Impossible Trinity

The central bank says its purchases of Treasury bills in the primary market was within "the leeway available in the reserve money programme."
"The above indicates that the continuous monitoring, precautionary actions and timely interventions by the Central Bank of Sri Lanka to ensure stability in the Sri Lankan financial markets has ensured that the Sri Lankan economy maintains stability and is able to withstand the current turbulent global financial markets, with confidence," the Central Bank said.
"Even in the future, the Central Bank would continue to monitor the conditions carefully and respond to the needs of the economy with suitable interventions, if and when any further interventions are required."
But analysts have warned the central bank several times that there is no 'leeway' in a reserve money targeting program if a peg is maintained.
Any sterilization (sales or purchases of T-bills) would either 'crowd out' the private sector (sales of t-bills) or create inflationary and exchange rate pressure (purchases of bills).
In 2007 the central bank's reserve money program was undermined by similar actions resulting in 20 percent plus inflation and a foreign exchange crisis in the middle of the year.
To effectively run any type of independent monetary policy, a floating exchange rate is needed and a peg has to be abandoned.
This is a well understood monetary phenomenon associated with pegged exchange rates, known as the impossible or 'unholy' trinity which says that independent monetary policy (in the current instance liquidity injections to prevent interest rates from skyrocketing) is impossible while maintaining a peg and permitting the free flow of foreign exchange.