econ-money policy and fiscal policy uncertainty

[h21]

hi all, i have a question about two scenarios
in exapansionary money policy and restrictive fiscaal policy, in high capital mobility model, why are we sure the exchannge raate will depreciate
same as reestrictive money policy and expansional fiscal policy, under low capital mobility mode, why are we uncertain about the exchange rate then?
Thanks

 

[krokodilizm]

I guess there is no intuitive and short way to put it. Everyone explains using a chain of events and that makes it a binary mess. I found http://www.analystforum.com/forums/cfa-forums/cfa-level-ii-forum/91326025this thread very neat though. The key is that “with high capital mobility, capital flow is the dominant factor, while with low capital mobility, net import/export (trade flow) is the dominant factor in determining exchange rate”.

 

[thalesian]

I think it is hard to digest Mundell-Flemming (M-F) without seeing it presented graphically. M-F can be presented as an extension of the IS-LM with an extra “line” for Balance of Payments. Unfortunately, the CFAI books only provide a cursory overview, but you can get a good taste from the graphic (https://en.wikipedia.org/wiki/Mundell–Fleming_model) in the Mechanics section of the Wikipedia page.
We can the diagram to answer the first question:
(1) In expansionary money policy and restrictive fiscal policy, in high capital mobility model, why are we sure the exchange rate will depreciate?
When BoP is horizontal (high capital mobility case), we get:
(a) “restrictive fiscal policy” = this shifts the IS curve inward (down and left), taken alone this would lead to an lower interest rate
(b) “expansionary monetary policy” = this shift LM ouward (out and to the right), take alone this would also lead to a lower interest rate
Therefore, the effects move in the same direction. The interest rate is unambigously lower.
Finally, to get the currency impact, you need to know that a lower interest rate causes capital to seek higher yielding interest rates elsewhere in the world. Therefore, less people demand the currency (because it doesn’t pay as much as other currencies) and the currency depreciates.
(2) Same as restrictive money policy and expansionary fiscal policy, under low capital mobility mode, why are we uncertain about the exchange rate then?
This the case where the BoP is tending toward vertical (low capital mobility case) and it makes it much harder to draw. You have three lines and need to form an equilibrium. However, it should be easy to see that BoP matters in the case. Simply put, trade flows drive the output in the low capital mobility case.
As such, both expansionary monetary policy and expansionary fiscal policy need to work in the same direction as trade flow dominate (as stated above).
If they are both expansionary, then the currency will deprecate.
If they are both restrictive, the currency will appreciate.