Suppose an economy with a fixed exchange regime faces a rise in international interest rates. Capital will start to flow out and put pressure on the exchange rate. The economy will have no choice but to raise interest rates in order to stem the capital outflow at the risk of incurring a recession. Monetary independence is sacrificed in order to protect the peg. If the economy has a flexible exchange rate regime, the outflow of capital would lead to a depreciation of the currency.
Monetary independence is retained but at the expense of exchange rate instability.
Because economies can achieve only two out of the three objectives, there are theoretically only two exchange rate regimes to choose from, dubbed the corner solutions. One is a freely floating exchange rate regime that allows complete freedom in international transactions and permits policymakers to combat recessions at the cost of erratic exchange rate fluctuations. The second is a fixed exchange rate regime, which generates stability but at the expense of monetary independence. Policymakers can opt to impose capital controls, which can reconcile a relatively stable exchange rate with some monetary independence, but this is a different issue altogether. In between the two corner solutions are exchange rate regimes, such as an adjustable peg, crawling peg, managed float, basket peg, and a variety of other arrangements.