Abstract
In a regime of fixed exchange rates, the problem of achieving and maintaining simultaneous external and internal balance may seem in certain cases to be insoluble. These are the so-called dilemma cases, as for example a balance-of-payments deficit accompanied by a situation of underemployment. One of the great innovations of the Mundell-Fleming model was to show that both targets can be achieved by an appropriate combination of fiscal and monetary policies.This is made possible using what Mundell called principle of effective market classification, according to which each instrument must be used in relation to the objective upon which it has relatively more influence.
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Notes
- 1.
It must be emphasized that this is a principle which is valid within the ambit of the static theory of economic policy, which still constitutes a point of reference for scholars of this discipline. It is however as well to inform the reader that according to developments of the mathematical “control theory” applied to the instruments-targets problem, in a dynamic context, the Tinbergen principle is no longer generally valid. For further information on the matter, see Petit (1985). It is also important to point out that, after the traditional instruments-(fixed) targets approach, an optimizing approach to economic policy has been developed. This approach involves the maximization of a social welfare function (or of a preference function of the policy-maker) subject to the constraint of the model representing the structure of the economy. In order to avoid further burdening of the present chapter, we postpone the presentation of some considerations on this approach until the end of Sect. 23.8.1
- 2.
For an alternative graphic representation, based on a diagram on the axes of which the two instruments are measured, see Mundell (1962).
- 3.
On the relationship between the slope of the BB schedule and capital mobility, see Sect. 10.2.2
- 4.
As we have expressed the equation for the determination of income in terms of the demand for domestic goods (on the part of residents and non-residents), G is to be taken as (that part of) public expenditure directed at domestic goods.
References
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Gandolfo, G. (2016). Policy Implications of the Mundell-Fleming Model, and the Assignment Problem. In: International Finance and Open-Economy Macroeconomics. Springer Texts in Business and Economics. Springer, Berlin, Heidelberg. https://doi.org/10.1007/978-3-662-49862-0_11
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