Mundell Fleming Model
According to the Mundell-Fleming, what constraints may free capital movements place on monetary policy?
In this essay I will be discussing the way in which free capital flows can cause constraints on monetary policies. I will be looking at the balance of payments and how when it is applied to the Keynesian IS/LM model produces the Mundell - Fleming model. The Mundell - Fleming model shows the relationship between exchange rates and national income. Additionally, to further investigate this situation I will be looking into the ways in which monetary policies behave according to various exchange rate schemes, namely fixed and floating exchange rates.
The balance of payments consists of the current account and the capital account. In theory, these two accounts should balance. The current account concerns the imports and exports of goods and services. The largest component of the current account is net export and therefore the current account balance, which is the difference between exports and imports, moves with net exports. Exports are mainly affected by foreign economic conditions, for instance, when incomes rise in foreign countries, demand for exports will increase, therefore exports are exogenous. Imports however depend on domestic income, for instance when domestic incomes rise, consumers will buy more imported goods and services. Net export is equal to exports minus imports; therefore there is an inverse relationship between imports and net exports. Another important component of the balance of payments is the capital account which is inflow and outflow of financial capital which will flow into countries that have high rate of return, which can be reflected through interest rates. (Colander & Gamber, 2006, pages 273-274)
The Balance of payments curve is a curve that represents combinations of interest rates and income levels at a given exchange rate at which the private balance of payments is in equilibrium. The balance of payments
In this essay I will be discussing the way in which free capital flows can cause constraints on monetary policies. I will be looking at the balance of payments and how when it is applied to the Keynesian IS/LM model produces the Mundell - Fleming model. The Mundell - Fleming model shows the relationship between exchange rates and national income. Additionally, to further investigate this situation I will be looking into the ways in which monetary policies behave according to various exchange rate schemes, namely fixed and floating exchange rates.
The balance of payments consists of the current account and the capital account. In theory, these two accounts should balance. The current account concerns the imports and exports of goods and services. The largest component of the current account is net export and therefore the current account balance, which is the difference between exports and imports, moves with net exports. Exports are mainly affected by foreign economic conditions, for instance, when incomes rise in foreign countries, demand for exports will increase, therefore exports are exogenous. Imports however depend on domestic income, for instance when domestic incomes rise, consumers will buy more imported goods and services. Net export is equal to exports minus imports; therefore there is an inverse relationship between imports and net exports. Another important component of the balance of payments is the capital account which is inflow and outflow of financial capital which will flow into countries that have high rate of return, which can be reflected through interest rates. (Colander & Gamber, 2006, pages 273-274)
The Balance of payments curve is a curve that represents combinations of interest rates and income levels at a given exchange rate at which the private balance of payments is in equilibrium. The balance of payments
Bibliography: David Colander, Douglas Copeland and Jenifer Gamber (2006) Macroeconomics, McGraw-Hill Irwin Andrew Crockett (1993) Changing capital markets: implications for monetary policy Brian Hillier (1991), The macroeconomic debate: models of the closed and open economy, Oxford: Basil Blackwell N. Gregory Mankiw (2007) Macroeconomics, Worth Publishers