Mundell–Fleming model

The Mundell- Fleming model is a working model of economics. It was independently developed by Robert Mundell and Marcus Fleming and describes in contrast to the IS- LM model open, not closed economies.

Basic model

The model describes a small economy, coupled with other countries through trade and cross-border capital flows, and shows what policy options exist and how the country reacts to changes in the internal and external conditions.

For this reason, there is in addition to the IS curve, which represents the locus of all equilibria in the goods market, and the LM curve, which maps all equilibria in the money market, a third curve: the ZZ curve, sometimes called FE- curve called. This curve represents all external balances of zero, that is, all interest income combinations in which net exports and net capital outflows to add zero.

The ZZ curve is described by the following equation ( assuming complete free movement of capital ):

,

Where the interest rate ( nominal ) exchange rate is at the time and expected for the next period exchange rate.

In the equilibria of the economy must now be made between a domestic, one foreign economic and macroeconomic equilibrium. As economic balance within the intersection of IS and LM curve is denoted by macroeconomic equilibria are represented by the ZZ curve. An economy is only in the macroeconomic equilibrium when the internal equilibrium is on the ZZ curve. It must therefore pass through the point of intersection of the IS- and LM curve.

Comparative Statics

Use the Mundell -Fleming model to take your fiscal or monetary policy, both for the case of flexible and fixed exchange rates, the behavior of interest rates and output due to expansionary (or contractionary ). In the following, full capital mobility is always assumed.

• Flexible exchange rates: The IS curve shifts due to increased government spending initially to the right ( yes, it is - so is higher for each of the associated output). The new intersection of IS and LM curve will mean a higher interest rate with them. This triggers an unlimited capital influence from abroad, which increases the demand for the domestic currency. As a result, the domestic currency enhances. Assuming that the Marshall Lerner condition is satisfied, this leads to a decrease in the export and thus at a lower output. Graphically, this is shown by the fact that the IS curve shifts with time after links to their original position.
• Fixed exchange rates: The IS curve shifts due to increased government spending initially to the right ( yes, it is - so is higher for each of the associated output). The new intersection of IS and LM curve will mean a higher interest rate with them. This triggers an unlimited capital influence from abroad, which increases the demand for the domestic currency. Thus, the value of domestic currency increases relative to foreign, but what is to be blocked in a fixed exchange rate regime just by the central bank. It does so by expanding the money supply and thus interest rates have fallen, and as long as the domestic interest rate is higher than the foreign interest rate - the LM curve therefore shifts downward until a state of equilibrium will be established. In this equilibrium, the interest rate is the same again as before, since he always has to correspond to the foreign. However, the increase was not compensated.

So it follows that expansionary fiscal policy effectively, in a flexible regime in a fixed exchange rate regime is, however, no effect.

• Flexible exchange rates: is due to the money supply increase again lower than before (or will increase the money supply by lower realized), so that the LM curve shifts down. This implies a higher output. The new point of intersection of the IS- and LM curve is characterized with ZZ curve. This is because a lower interest rate induces an outflow of capital, then because investors prefer investments held abroad. This increases the demand for foreign currency ( and decreases after the domestic currency ). This would result in a downward pressure on the home currency. The lower induced under which an increase in investment (), and thus also of. This is represented graphically by a rightward shift of the IS curve.
• Fixed exchange rates: is due to the money supply increase again lower than before (or will increase the money supply by lower realized), so that the LM curve shifts down. This implies a higher output. The new point of intersection of the IS- and LM curve is characterized with ZZ curve. This is because a lower interest rate induces an outflow of capital, then because investors prefer investments held abroad. This increases the demand for foreign currency ( and decreases after the domestic currency ). This would result in a downward pressure on the home currency, which should be in a fixed exchange rate regime but just prevented by the Central Bank. It controls the other hand, by reversing the (expected) price increase of foreign currency by a corresponding sale of foreign exchange holdings, and this will reduce the stock of domestic currency for purchased. But that is just a shift of the LM curve shown up so that finally the whole measure is revised again.

So it follows that expansionary monetary policy in a flexible exchange rate regime effectively, in a fixed regime is, however, no effect.

Model extension

A further development is the two-country Mundell- Fleming model, in which even large countries and their repercussions are modeled on the "rest of the world."

Is derived from the Mundell -Fleming model, the AD curve.