Mundell-Flemming Model – use the mundell fleming model to predict

Robert Mundell and Marcus Fleming set up the Mundell-Fleming Model. This model is different from the IS-LM model in the sense that the former deals with a small open economy while the latter deals with autarky.

The Mundell- Fleming Model can b explained with the help of the following equations:The IS component is expressed as

Y = C + I + G + NXWhere Y: GDP

C = C(Y – T,i – E(p))
Where C: Consumption
T: Taxes
I: Interest Rate
E(p): Expected inflation rate

I = I(i – E(p),Y – 1)Where Y – 1 : previous period GDP
I is investment

G = G where G: Government spending exogeneously given

NX = NX(e,Y,Y * ) Where NX : Net exports
e : Real exchange rate
Y * : GDP of the foreign country

LM component

M/P=L(i,Y)
Where M: money supply
P: average price
L: liquidity
BOP Component

CA = NXWhere CA: Current Account

KA = z(i – i * ) + k
Where z: capital mobility
i *: foreign interest rate
k: capital investment exogeneously fixed
The Mundell-Flemming Model assumes that the domestic and the international interest rates are the same. The exchange rate is also assumed to be flexible where market forces lone determine it and government intervention is nil.