Mundell-Fleming model

Mundell-Fleming model: The Hallmarks of the Mundell-Fleming Model

Mundell-Fleming model: Diagrammatic Representation

Mundell-Fleming model: Policy Shocks

Mundell-Fleming model: Coining of the Expression

TheMundell-Fleming model, named for J. Marcus Fleming (1911 76) and Robert A. Mundell (born 1932), in its most familiar form is the ‘‘internationalized IS-LM model,’’ a diagrammatic representation of the way in which a small, open economy responds to shocks that take the form of internal policy initiatives. The innovation in this approach is that the exchange rate regime is a crucial determinant of the policies’ effects on economic variables, and specifically on the level of gross domestic product (GDP) generated by the country under analysis. In two particular cases, contrary to expectations, these initiatives do not have an impact on output in the small, open economy in the perfect capital mobility setting. This is true both for monetary policy under fixed exchange rates and for fiscal policy under flexible exchange rates. For these situations the model shows that the initiatives are ineffective for influencing the level of output and employment.

The clear implication is that policymakers should be aware of the impotence of these initiatives and not rely on them in a fruitless attempt to stabilize the economy. Canada was faulted in the late 1950s for depending on expanded government expenditures to end a stubborn recession. Fleming’s ineffectiveness result demonstrates that the impact ofCanada’s fiscal policy was vitiated because the Bank of Canada allowed the price of its dollar to be determined in the financial markets, rather than fixing it at a given value. The clumsy conduct of monetary policy by the Bank of Canada at the time was particularly unfortunate because this flexible exchange rate regime enhanced the potency of that policy. Although these observations were articulated by Fleming and Mundell a few years after these events, the intuitive feeling at the time was that something was amiss at the Bank of Canada, and dissatisfaction with its policies lay behind the impeachment of its governor in 1961.

See also capital mobility; exchange rate regimes; impossible trinity; New Open Economy Macroeconomics; quantity theory of money; Swan diagram

FURTHER READING

• Boughton, James. 2003. ‘‘On the Origins of the Fleming MundellModel.’’ IMF Staff Papers 50 (1) (April): 1 9. Analyzes the writing of Fleming’s 1962 contribution to the Mundell Fleming model and concludes that Flem ing’s work was substantially independent of Mundell’s. 
• Cooper, Richard N. 1976. ‘‘Monetary Theory and Policy in an Open Economy.’’ Scandinavian Journal of Economics 78 (2) (June): 146 63. Provides an analysis of financial policies in the open economy and calls the conventional framework at the time ‘‘the Fleming model.’’ 
• Fleming, J. Marcus. 1962. ‘‘Domestic Financial Policies under Fixed and under Floating Exchange Rates.’’ IMF Staff Papers 9 (4) (November): 369 79. Considered to be the classic contribution by Fleming, this paper reports both verbally and mathematically the ineffectiveness result for fiscal policy, and the proportionality result for monetary policy for the flexible exchange rate, perfect capital mobility case. 
• Frenkel, Jacob A., and Assaf Razin. 1987. ‘‘The Mundell Fleming Model a Quarter Century Later.’’ IMF Staff Papers 34 (4) (December): 567 620. Characterized by the authors as a survey piece, this paper presents a complicated two country model of the world econ omy in the perfect capital mobility setting. Since the analysis specifies the asset markets in a portfolio balance manner, the connection between this framework and what is usually termed the Mundell Fleming model is unclear. 
• Hicks, John. 1937. ‘‘Mr. Keynes and the ‘Classics’: A Sug gested Interpretation.’’ Econometrica 5 (2) (April): 147 59. The diagram included in this article has been the basis for most textbook presentations of closed economy macroeconomic theory right up to the present. The longevity of this framework has surprised both its pro ponents and its many critics. 
• Kenen, PeterB. 1985. ‘‘MacroeconomicTheory and Policy: How the Closed Economy Was Opened.’’ In Handbook of International Economics, vol. 2, edited by RonaldW. Jones and Peter B. Kenen. North Holland, Amsterdam, 626 77, chapter 13. A survey piece that covers the tra ditional way of thinking about the development of the open economy macroeconomic model, using a number of distinct models and different modes of analysis. 
• Marston, Richard C. 1985. ‘‘Stabilization Policies in Open Economies.’’ In Handbook of International Economics, vol. 2, edited by Ronald W. Jones and Peter B. Kenen. North Holland, Amsterdam, 859 916, chapter 17. Presents a portfolio balance analysis of the effects of standard macroeconomic shocks. The author uses a complex model and the stock specification of the asset markets. He describes his framework as a ‘‘modified Mundell Fleming model.’’
•  McCallum, Bennett T. 1996. International Monetary Eco nomics. New York: Oxford University Press. A standard presentation of open economy macroeconomic topics. The author concludes that Mundell’s 1962 and 1963 papers are his central contributions to the Mundell Fleming model. 
• Mundell, Robert A. 1960. ‘‘The Monetary Dynamics of International Adjustment under Fixed and Flexible Ex change Rates.’’ Quarterly Journal of Economics 74 (2) (May): 227 57. Includes a model specifically designed so that the comparative static responses of the values of real variables are independent of the nature of the ex change rate regime. Despite its title, this article includes neither the money supply nor the exchange rate in the central mathematical model, which one finds in its ex tensive appendix. 
• . 1961. ‘‘Flexible Exchange Rates and Employment Policy.’’ Canadian Journal of Economics and Political Science 27 (4) (November): 509 17. Although the fixed exchange rate case is not treated explicitly in this pre sentation, its conclusions appear to conflict with those published in the famous paper two years later. In par ticular, monetary policy seems to have potency under fixed exchange rates, and fiscal policy is reported as being effective under flexible exchange rates. 
• . 1962. ‘‘The Appropriate Use of Monetary and Fiscal Policy for Internal and External Stability.’’ IMF Staff Papers 9 (1) (March): 70 77. Presents in a dynamic form an argument found at the end of anotherMundell article, which deals with the appropriate response to a situation of internal and external imbalance. This article has been the basis for the author’s thinking about the ‘‘policy mix’’ and supply side economics.
•  . 1963. ‘‘Capital Mobility and Stabilization Policy under Fixed and Flexible Exchange Rates.’’ Canadian Journal of Economics and Political Science 29 (4) (No vember): 475 85. Mundell’s most frequently cited pa per. Reports results like those in Fleming (1962), espe cially for the flexible exchange rate, perfect capital mobility case. Juxtaposes the Fleming and Hume inef fectiveness results and presents the famous ‘‘inter nationalized IS LM’’ diagram. 
• Obstfeld,Maurice, and Kenneth Rogoff. 1996. Foundations of International Macroeconomics. Cambridge,MA:MIT Press.Amonumental textbookpresenting the state of the subject at the time of publication. The analysis focuses on current account dynamics for its real coverage, and on the flexible exchange rate case in its monetary topics. It has an extensive treatment of the Dornbusch ‘‘over shooting’’ framework, which the authors call the ‘‘Mundell Fleming Dornbusch model’’ 
• Rhomberg, Rudolph R. 1964. ‘‘A Model of the Canadian Economy under Fixed and Fluctuating Exchange Rates.’’ Journal of Political Economy 72 (1) (February): 1 31. Finds that government expenditures are likely to lead to an appreciation of domestic currency in the in termediate run. This argument may have inspired Fleming to write downhismodel so as to explain howthe effects of fiscal policy were vitiated in Canada in the late 1950s. 

RUSSELL S. BOYER