Question

If a country has flexible exchange rate regime with perfect capital mobility, then according to the Mundell-Fleming Model, an expansionary fiscal policy will lead to

• A. no change in output
• B. reduced net exports
• C. appreciation of nominal exchange rate
• D. expansion of output

Hint:

In the Mundell-Fleming Model with perfect capital mobility and a flexible exchange rate, fiscal policy does not affect output because the exchange rate adjusts.

Answer 1

The Correct Option is A, B, C

Step 1: Understand the Mundell-Fleming Model.
The Mundell-Fleming Model is a model of an open economy that describes the relationship between exchange rates, capital mobility, and fiscal and monetary policies. When capital is perfectly mobile, changes in fiscal policy (like an expansionary fiscal policy) do not affect output because the exchange rate adjusts to maintain equilibrium in the balance of payments.
Step 2: Evaluate the options.
- (A) no change in output: This is correct. With perfect capital mobility and a flexible exchange rate, expansionary fiscal policy causes the currency to appreciate, but it does not affect output because the increase in government spending is offset by the appreciation of the exchange rate.
- (B) reduced net exports: This is incorrect. While the currency appreciates, the effect on net exports is balanced by the changes in capital flows.
- (C) appreciation of nominal exchange rate: While the exchange rate does appreciate, the focus of the question is on output, not the exchange rate itself.
- (D) expansion of output: This is incorrect. Under the Mundell-Fleming model with perfect capital mobility, an expansionary fiscal policy does not change output.
Step 3: Conclusion.
The correct answer is (A). Final Answer: (A) no change in output