The Mundell-Fleming Economic Model - 50MINUTES - ebook

The Mundell-Fleming Economic Model ebook

50MINUTES

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Opis

Achieving macroeconomic equilibrium

This book is a practical and accessible guide to understanding the Mundell-Fleming model, providing you with the essential information and saving time. 

In 50 minutes you will be able to: 

   •  Learn about the IS-LM model that the Mundell-Fleming is based on and how each of the three curves of the model graph are formed, as well as how to interpret them
   • Analyze different exchange rate regimes and the effect they have on production, income and interest rates 
   • Understand the effectiveness of budgetary, fiscal and monetary policies and how they interact with exchange rates

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The Mundell-Fleming economic model

Key information

Names: Mundell-Fleming model, IS-LM model for an open economy, IS-LM-BoP model, IS-LM-BP model.Uses: this model is at the heart of international macroeconomics as it includes foreign trade and capital movements within a closed economy (national scale). It is:the basic model of the IMF (International Monetary Fund);the theoretical argument in favour of establishing a European monetary union;the general framework of economic policy within the Eurozone.Why is it successful? The Mundell-Fleming model: helps us to understand how the choice between a fixed or variable exchange rate affects the efficiency of economic policies in an economy that is open to international trade;generalises Keynesian theory in the case of an open economy;allows us to anticipate the effects of the removal of customs duties and the explosion of capital markets, as well as the international transmission of economic monetary shocks;shows how a country can use budgetary and monetary policies to simultaneously achieve balance both within its borders and outside of them;states that both monetary policy with flexible exchange rates and fiscal policy with fixed exchange rates are effective;defends the idea that the European Central Bank must be independent and responsible for price stability so as not to flood the money market, which would induce a loss in value.Key words:Balance of payments (BP): balance sheet of all movements of goods and services, capital and currencies across the borders of a country over a specific period.Central rate: the official exchange rate of one currency against another. In the EMS (European Monetary System), the central rate is the official parity of a currency as determined by the ECU (European Currency Unit).Currency: all means of payment used in a country.European Monetary System (EMS): a system based on the principle of stable exchange rates between the currencies of the member countries of the EMS. This system was based on the ECU (European Currency Unit, a basket of the currencies of the countries involved, firstly those in the European Economic Community (EEC), then those in the European Union before the adoption of the euro). It was approved during the European summit in Bremen in July 1978 and the European Council in Brussels in December 1978.Exchange rate: price of one currency expressed in domestic currency. In other words, it is the amount of national currency needed to purchase a unit of foreign currency.Fixed exchange rate: a link that completely fixes the value of one currency in relation to another, with very limited fluctuation possibilities compared to the benchmark price.Fluctuation band: exchange rate regime which defines the fixed parity of national currency against foreign currency, and which also allows for fluctuations relative to its benchmark price.Foreign currency: currency that can be exchanged with national currency.Impossible trinity: developed by Canadian economist Robert A. Mundell (born in 1932), this principle reflects the conflict between the autonomy of monetary policy, fixed exchange rates and international capital movement.Interest rate: premium for the consumption or immediate use of money.Open economy: an economy that freely participates in international trade and for which exportations represent a significant share of gross domestic product (GDP).Optimum currency area: geographic areas within which a fixed exchange rate is the best internal solution, and a variable exchange rate is the best external solution.Parity (central/crawling peg): fixed exchange rates defined in relation to a benchmark and which determine the conversion of one currency into another. Parity can be central, where central banks inform markets of the parity that is considered desirable; or there are crawling peg exchange rates, where the exchange rate is set periodically.

Introduction

Since the economic development of countries results in the growing mobility of capital and the increase in international trade, the world’s economies have become increasingly interdependent. The relations between countries include not only the flow of goods involving the import and export of goods and services, but also international payments, due to the different currencies that exist depending on the economic area.

A good understanding of international trade, as well as the potential consequences of transactions between the residents of a country and foreign actors, is therefore essential. The Mundell-Fleming model seeks to conceptualise the need to incorporate international trade into the analysis model of national macroeconomic balance (IS-LM model). In doing so, a macroeconomic balance is achieved in an open economy.

Definition of the model

The Mundell-Fleming model is an open economy extension of the famous macroeconomic balance IS-LM model, created in 1937 by John R. Hicks (British economist, 1904-1989) and Alvin H. Hansen (American economist, 1887-1975). Presented by leading economists Robert Mundell and Marcus Fleming (Scottish economist, 1911-1976), it allows for the analysis of the role played by the international mobility of capital in the effectiveness of macroeconomic policy under different exchange rate regimes.