Question

Explain Mundel-Fleming Model. After that, explain the case where Monetary Policy is available and the case where Fiscal Policy is available by using the model.

(It's an essay question, please write in detail)

Answer 1

1. Basically, this model is used to oppose the imaginations of maintaining a fixed exchange rate, independent monetary policy and free movement of capital. This is also known as ''impossible trinity'' or "Mundell–Fleming trilemma."

2. This is an economic model which is evaluated by the economists Robert Mundell and the other Marcus Fleming independently.

3, According to the model, when there is perfect capital mobility, the interest rates can't be denied from deviating compared to those prevailing abroad under the fixed exchange rate regime. Hence concluding that the monetary policies in a small economy which is open is not effective in order to make an impact on nation's income and employment. If an attempt is made in order to reduce the interest rates, then a phenomenon of depreciation occurs in the currency of the home country. So this clearly indicates that under a fixed exchange rate regime, central bank of a country cannot take a decision of forming an independent monetary policy.

4. Fiscal policy is available when the expansionary monetary policy is not effective under fixed exchange regime giving the economy a perfect capital mobility. This also leads to increase an impact of nation's income and employment. The fiscal policy increases the demand in aggregate and makes a shift in IS curve to the right. This offers higher interest rates and also attracting capital into the economy. This increases the national income.

5. In this way both the policies clash towards each other striving to improve the national income and also the levels of the employment. Both the policies have their own effectiveness to a given situation or a regime.