Question
According to the Mundell-Fleming model, what will happen
in the short run if an expansionary fiscal policy is undertaken under flexible exchange rates and perfect capital mobility?Solution
According to the Mundell-Fleming model, in the short run, if an expansionary fiscal policy is undertaken under flexible exchange rates and perfect capital mobility, national income remains unchanged and the exchange rate appreciates. This is because the fiscal expansion leads to capital inflows, which cause the currency to appreciate, offsetting the expansionary effect on income.
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