Mundell-Fleming Model

Evidence and data

Use capital mobility, exchange-rate regime, reserves, external balance, and interest differentials to decide which policy result applies.

Calibration or measurement

Capital mobility and exchange-rate pass-through are the key scenario choices. They determine whether monetary or fiscal policy carries the larger effect.

Boundaries

• Perfect capital mobility is a limiting case.
• Balance-sheet currency mismatches can reverse textbook depreciation effects.
• Expectations and risk premia need explicit additions.

Use guidance

When sufficient

Comparative statics on monetary and fiscal policy in a small open economy under perfect capital mobility. The key questions: does a monetary expansion raise or lower the exchange rate, and does a fiscal expansion crowd out net exports? The model gives clean directional answers when the exchange-rate regime and capital-mobility assumption are specified.

When sketch only

Use the diagram to build intuition about the trilemma, not to predict magnitudes. The model assumes instantaneous capital flows, no balance-sheet effects, and no expectations dynamics. Where sterilized intervention, currency mismatch, or sovereign risk premia dominate, the textbook results can reverse.

When to switch

Switch to a New Keynesian small open economy model (dsge:soe-nk, e.g., Gali-Monacelli 2005) when the question requires endogenous pricing, forward-looking exchange-rate expectations, or an estimated transmission of monetary policy through the import channel.

Falsification signal

A floating-rate economy with near-perfect capital mobility where fiscal expansion raises output without any offsetting current-account deterioration or exchange-rate appreciation contradicts the model's core prediction for that regime. If fiscal multipliers behave as if capital mobility were zero despite an open capital account, the model's trilemma mapping is broken.