Under a regime of perfect capital mobility and a

Solution

In the Mundell-Fleming model with flexible exchange rates and perfect capital mobility, expansionary fiscal policy shifts the IS* curve to the right. This puts upward pressure on the interest rate, attracting foreign capital. The resulting demand for domestic currency causes an appreciation of the exchange rate (E). This appreciation makes domestic goods more expensive relative to foreign goods, leading to a decrease in net exports that exactly offsets the initial fiscal expansion, leaving Y unchanged (the "crowding out" occurs via the trade balance).