Question

9.    Use 2 graphs to explain, in the Mundell-Flemming model, under flexible and then fixed exchange rate arrangement, the impact of money supply decrease on output and exchange rate.

Answer 1

The Mundell–Fleming model has been used to argue that an economy cannot simultaneously maintain a fixed exchange rate, free capital movement, and an independent monetary policy. An economy can only maintain two of the three at the same time.

A money supply decrease will decrease output and increase exchange rate.