CATO JOURNAL A country can choose between a fixed or flexible foreign exchange rate regime; and the selection, in turn, affects the effectiveness of monetary and other macroeconomic policies Key theories related to the exchange rate regime include the"dual istic conflict"and the"impossible triangle. " The former, as explained in the Mundell-Fleming model under the assumption of free capital flows, demonstrated that monetary policy is ineffective in a fixed exchange rate arrangement, but effective under a floating arrange- ment. That is, the independence of monetary policy conflicts with the ixed exchange rate regime, and you can have only one of them. The theory of the"impossible triangle"(Obstfeld and Taylor 1998)expand ed the Mundell-Fleming model, and showed that a govemment can only select two out of the following three goals: an independent mon- etary policy, a fixed exchange rate, and capital mobility However, neither theory can explain any other combination except for the extreme ("comer solution")cases of these three elements, which can be applied to the current situation in China. Yi Gang and Tang Xuan 2001)developed a more general theory of the"expanded triangle, and argued"an economy shall opt for different exchange rate systems in dif ferent stages. "In cases of insignificant capital flows and less-developed derivative markets, an"intermediate "solution can help economic enti- ties manage exchange rate risks. However, in case of large-scale capital flows and developed derivative products, a country has to take specula- tive attacks in addition to exchange rate risks into consideration when an intermediary arrangement is adopted, the subsequent moral hazard and confidence crisis may turn out to be the root causes of monetary cri- sis.Therefore, after the free flow of capital is achieved, the exchange rate ystem will acquire added flexibility or turn into a currency coalition. Eventually, the"comer solution" will prevail A large economy like China cannot give up the independence of monetary policy. Therefore, China has to choose between a fixed exchange rate and the free flow of capital; in a sense, it has to choose between stability and efficiency (Yi 2000). Over the long run, China bound to have a free flow of capital and a floating exchange rate regime Labor Productivity and Total Factor Productivity Changes A number of factors have contributed to the fluctuation of rmB exchange rates. These factors include, among others, labor produc tivity and total factor productivityA country can choose between a fixed or flexible foreign exchange rate regime; and the selection, in turn, affects the effectiveness of monetary and other macroeconomic policies. Key theories related to the exchange rate regime include the “dual￾istic conflict” and the “impossible triangle.” The former, as explained in the Mundell-Fleming model under the assumption of free capital flows, demonstrated that monetary policy is ineffective in a fixed exchange rate arrangement, but effective under a floating arrange￾ment. That is, the independence of monetary policy conflicts with the fixed exchange rate regime, and you can have only one of them. The theory of the “impossible triangle” (Obstfeld and Taylor 1998) expand￾ed the Mundell-Fleming model, and showed that a government can only select two out of the following three goals: an independent mon￾etary policy, a fixed exchange rate, and capital mobility. However, neither theory can explain any other combination except for the extreme (“corner solution”) cases of these three elements, which can be applied to the current situation in China. Yi Gang and Tang Xuan (2001) developed a more general theory of the “expanded triangle,” and argued “an economy shall opt for different exchange rate systems in dif￾ferent stages.” In cases of insignificant capital flows and less-developed derivative markets, an “intermediate” solution can help economic enti￾ties manage exchange rate risks. However, in case of large-scale capital flows and developed derivative products, a country has to take specula￾tive attacks in addition to exchange rate risks into consideration. When an intermediary arrangement is adopted, the subsequent moral hazard and confidence crisis may turn out to be the root causes of monetary cri￾sis. Therefore, after the free flow of capital is achieved, the exchange rate system will acquire added flexibility or turn into a currency coalition. Eventually, the “corner solution” will prevail. A large economy like China cannot give up the independence of monetary policy. Therefore, China has to choose between a fixed exchange rate and the free flow of capital; in a sense, it has to choose between stability and efficiency (Yi 2000). Over the long run, China is bound to have a free flow of capital and a floating exchange rate regime. Labor Productivity and Total Factor Productivity Changes A number of factors have contributed to the fluctuation of RMB exchange rates. These factors include, among others, labor produc￾tivity and total factor productivity. 190 Cato Journal