Mundell-fleming Model

Typically, the Mundell-Fleming model portrays the relationship between the nominal exchange rate and the economy output (unlike the relationship between interest rate and the output in the IS-LM model) in the short run. The Mundell-Fleming model is frequently referred to as "the Unholy Trinity," the "Irreconcilable Trinity," or the Mundell-Fleming "trilemma."

DIFFERENCES FROM IS-LM

It is worth noting that some of the result from this model differs from the IS-LM because of the Open Economy assumption. Result for Large Open Economy on the other hand falls within the result predicted by the IS-LM and the Mundell-Fleming models. The reason for such result is because a large open economy has both the characteristics of an autarky and a small open economy.

In the IS-LM, interest rate will be the key component in making both the money market and the good market in equilibrium. Under the Mundell-Fleming framework of small economy, interest rate is fixed and equilibrium in both market can only be achieved by a change of nominal exchange rate.

EXAMPLE

Consider an exogeneous increase in government expenditure, the IS curve will shift upward, with LM curve intacts, causing the interest rate and the output to rise (partial crowding out effect) under the ISLM model.

curve (of exchange rate and output) is vertical, which means there is exactly one output that can make the money market in the equilibrium under that interest rate. Even though the IS--- curve still shift up, it will result in a higher exchange rate and same level of output (complete crowding out effect, which is different in the IS-LM model).

HISTORY

The model was first set forth by Robert Mundell and Marcus Fleming . The two worked separately however, with each of them publishing a series of independent papers in the 1960s .

FURTHER READING

Carlin and Soskice, Macroeconomics and the Wage Bargain, Mankiw, Macroeconomics and Blanchard, Macroeconomics.

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Mundell-fleming Model