Reading 14 LOS 14K: I am having trouble answering questions which ask how changes (expansionary vs restrictive under either High or Low Capital mobility) affect the currency i.e. whether this results in appreciation or depreciation under the Mundell-Fleming Model. Is there some intuition to remember this? Please share how best to get this right. Thanks.
With low capital mobility , the effect of policies on currency values is solely on trade flows.
Basic: Increase in Aggregate Demand (AD) = Imports > Exports = Increase in trade deficits. (this just means that the increase in imports is greater than the increase in the amount of exports)
Decrease in AD = Exports > Imports = Increase in trade surplus
Note: Countries running trade deficits will see their currencies depreciate
Countrues running trade surpluses will see their currencies appreciate.
Expansionary Monetary policy = increase in money supply = more money to spend = increase in AD = Depreciation of currency
Restrictive monetary policy = decrease in money supply = less money to spend = decrease in AD = Appreciation
Expansionary fiscal policy = more govt spending/less taxes which means hey we can now buy stuff we don’t need since our disposable income has gone up = increase in AD = Depreciation
Restrictive fiscal policy = less disposable income = decrease in AD = Appreciation
Put it all together:
Expansionary monetary/fiscal policy = Depreciation/Depreciation = Depreciation
Expansionary monetary & restrictive fiscal policy = Depreciation/Appreciation = Uncertain
Restrictive monetary/fiscal policy = Appreciation/Appreciation = Appreciation
Restrictive monetary & expansionary fiscal = Appreciation/Depreciation = Uncertain
Keji - thank you for this! I am really struggling with econ but this is a great way to remember this concept! If you have any other punchy ways to help with ethics please could you send them my way at: trade4u100@googlemail.com Thanks
I use this little trick to remember the effect of monetary and fiscal policy.
Start with the restrictive monetary policy, the currency will always appreciate regardless of the mobility of the capital (the opposite monetary policy will surely have the opposite effect)
High mobility capital, the opposite fiscal policy (expansionary) will have the same effect as the restrictive monetary.
Low mobility capital, the “same” fiscal policy (restrictive) will have the same effect as the restrictive monetary.
It worked well for me 