Mundell-Fleming Model

1. Mundell-Fleming Model John Lydon, John Connelly, Greg Rodilosso, Emily Thomas, Raina Tripp, Paul Sicilian Fiscal/Monetary Policy Biographies • Expansionary Monetary Policy- Flexible Exchange Rate: • LM right, r decreases • Capital outflows, demand for currency decreases, depreciates. • Net Exports increases; IS shift right until r=rw • Income increases Expansionary Monetary Policy – Fixed Exch. Rate • Expansionary Fiscal Policy- • Fixed Exchange Rate: • IS curve shifts right • r increase, Y increase • Inflow of foreign capital; increase in demand for currency; appreciation • Buy foreign currency to keep Exch. Rate • Money supply increases • LM shifts right • Effective in changing Y because it forces an accommodative monetary policy Expansionary Fiscal Policy – Flexible Exch. Rate • Robert Mundell: • Born in Canada, 1932 • Ph.D. from M.I.T., 1956 • Taught at Stanford and Johns Hopkins University • Joined staff of International Monetary Fund in 1961 • Has been Adviser to a number of international agencies & organizations: United Nations, World Bank , IMF, European Commission, several governments in Latin America & Europe, the Federal Reserve, and the US Treasury • Prepared one of the first plans for a common currency in Europe (Euro) • Some Significant Awards: • Guggenheim Prize (1971) • Nobel Memorial Prize in Economic Science (1999) Expansionary Fiscal Policy – Fixed Exch. Rate • Expansionary Fiscal Policy- Flexible Exchange Rate: • Allow currency to appreciate as long as the domestic interest rate>world interest rate • M increase, X decrease • Net Exports offset the expansionary policy; IS shifts back • Expansionary Monetary Policy- Fixed Exchange Rate: • LM shifts right • r decreases • Causes capital outflows; demand for currency • Currency depreciates • Need to keep exch. Rates fixed; 2 options: • Expansionary Fiscal • Reverse Monetary Policy Expansionary Monetary Policy – Flexible Exch. Rate • Marcus Fleming: • Worked as the Deputy Director of the research department for International Monetary Fund • Worked on similar research of open economies to Mundell’s previous to their collaboration • In the Mundell-Fleming Model, Mundell’s work overshadows Fleming’s • Died in 1976 Implications • First model in early 1960’s to integrate international monetary flows into macroeconomic analysis • Extended the IS/LM Model to show how exchange rates and capital flows can create internal and external balance • Formed the idea of an Open Economy • First to integrate international monetary flows into macroeconomic analysis • Showed international flows can determine Real National Income, Unemployment, and Interest Rates • Showed the importance of the exchange rate • Introduced the idea that small economies (BP horizontal) are different from large economies (BP upward sloping) • Predicted future development of international monetary arrangements and capital markets • Idea of floating exchange rates and common currency • Revolutionary at the time when most of the countries had fixed exchange rates • In the 1970s the model became more applicable as the Bretton Woods System disintegrated