Question

What would happen to the rate of interest, in new equilibrium, if the money supply rises in the Mundell-Fleming model under the flexible exchange rate and absolutely free capital mobility, if the international interest rate remains the same?

• A. It will rise.
• B. It will fall.
• C. It would either rise or fall.
• D. It would remain constant.

Hint:

What role does free capital mobility have on interest rates?

Answer 1

The Correct Option is D

In the *Mundell-Fleming model*, with perfect capital mobility and a flexible exchange rate, the money supply can increase without affecting the interest rate.

Capital flows freely across borders, balancing the domestic and international interest rates, so the rate of interest remains constant.

Hence, the correct answer is (d).