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Mundell–Fleming without the LM curve: the exogenous interest rate in an open economy

Franklin Serrano and Ricardo Summa

Keywords: Mundell–Fleming; exogenous interest rate; economic policy

Abstract

In this paper we evaluate critically the popular Mundell–Fleming model from the heterodox standpoint of the exogenous interest-rate approach. We criticize the assumptions of exogenous money supply, ‘perfect’ international capital markets and inelastic exchange-rate expectations. We show that in a more realistic framework none of the main results of the Mundell–Fleming model on the relative effectiveness of fiscal and monetary policies is valid, either in floating and fixed exchange-rate regimes. We conclude that, within certain very asymmetric bounds, the Central Bank has the power to determine the domestic interest rate exogenously even in open economy with free capital mobility and that there is no automatic market mechanism to ensure the automatic adjustment of the interest rate and exchange rate to sustainable levels.

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