The Mundell-Fleming Model And Monetary Policy: A Synthetic Analysis

The Mundell-Fleming model of open-economy macroeconomics originated in the two papers written respectively by Robert A. Mundell and J. Marcus Fleming in the early 1960s. The key contribution of the model has been a systematic analysis of the role played by international capital mobility in determining the effectiveness of macroeconomic policies under alternative exchange rate regimes. Since then, the model was extended in various directions and is still the main "workhorse" of open-economy macroeconomics.On the basis of the Mundell-Fleming model and various extended models, this paper develops a unified theoretical framework to analyze the monetary policy effectiveness of a small opening country under fixed and flexible exchange rate regimes with the precondition that the international capital has a full mobility. Attention is given to the flexible price of domestic output, the effectiveness of changes in the exchange rate on domestic price, the wealth effect of domestic private sector, the influences induced by whether the government bonds are neutral or not, and the stock-shift effect in the long-run equilibrium. For simplification, we only consider the policy effects under the assumption that the expectations are static, and ignore the facet of risk premium. Through analysis, we further clarify the key economic mechanisms operating in the Mundell-Fleming model and its significance, and find that the initial conclusions of the model should be modified in part.