Answer to Question #290408 in Macroeconomics for vena

Question

The Mundell - Fleming assuming imperfect capital mobility, analyze the effects of an expansionary fiscal policy. Consider the effect of the policy on the income when the exchange rate is fixed and when the exchange rate is flexible. Explain by using the appropriate graph. Give your conclusion regarding the effectiveness of policy.

Answer 1

If we have imperfect capital mobility, then the fiscal expansion causes a capital inflow as well as a trade balance deterioration. If capital mobility is great enough the former effect overcomes the latter and the exchange rate depreciates. This causes IS to shift left.