1. LECTURE 4: THE MUNDELL-FLEMING MODEL UNDER FLOATING RATES & HIGH CAPITAL MOBILITY

2. An increase in E, by stimulating Net Exports, shifts both the IS and BP curves.

3. The effect of a change in E, to study depreciation under floating. Answer: The IS curve shifts right, but the BP=0 curve shifts right by more.

4. When exchange rates float, capital mobility enhances monetary policy’s effect.

5. When exchange rates float, capital mobility cuts the effect of fiscal policy.

6. Recap of key results under floating κ lowers effect of G on Y – because conventional crowding out (i ↑=> A↓) is supplemented by new crowding out ( apprec.=> ↓). κ raises effect of M on Y –because conventional domestic stimulus (i ↓=> A↑) is supplemented by new foreign stimulus ( deprec.=> ↑).

7. Mundell-Fleming with perfect capital mobility As  → ∞, BP=0 curve becomes flat. i Y i=i* BP

8. Interpretation of BP curve also changes : –Now the BP curve is the statement i=i* (with i* exogenous, from the viewpoint of a small country). –Points above BP (or below) now correspond to “infinite” surpluses (or deficits), rather than finite. –Put differently, international financial arbitrage always forces the economy rapidly back onto the BP curve.

10. Fiscal expansion. If E is fixed, money inflow (instantaneous & immune to sterilization) brings i back down => full multiplier effect on Y; no crowding out. Monetary expansion. If E is fixed, money outflow (instantaneous & immune to sterilization) brings i back up => effect on Y = 0. If E floats, instantaneous appreciation brings i back down => effect on Y =0; 100% crowding out. If E floats, instantaneous depreciation brings i back up => maximum effect on Y.

11. THE IMPOSSIBLE TRINITY We can attain any two of the three desirable attributes, but not all three Perfect Capital Mobility (Financial Integration) Fixed Exchange Rates (Currency Integration) Monetary Independence (Full National Sovereignty)

13. Why does i ≠ i*, in practice? Country factors, e.g., as measured by: sovereign spread or local i $ -US i $. –Capital controls –Taxes on financial transactions –Transaction costs –Imperfect information –Default risk –Risk of future capital controls Currency factors, e.g., as measured by: local i local currency - local i $. –Expected currency depreciation –Exchange risk premium