Mundell-Fleming model of exchange rate determination

[DJS05101985]

I’m having a lot of difficulty understanding this.
Here is what makes sense:
Expansionary monetary policy, i.e. reducing interest rates, will put downward pressure on exchange rates whereas expansionary fiscal policy will increase spending, and by extension debt financing, and put upward pressure on exchange rates.
Here is what I don’t get:
1)
expansionary monetary + expansionary fiscal + low capital mobility = depreciation of currency
expansionary monetary + expansionary fiscal + high capital mobility = ambiguous movement in exchange rate
So, expansionary montary and fiscal policy have opposite forces on exchange rates but why does expansionary win in a low capital mobility scenario in this particular environment.
2)
expansionary monetary + restrictive fiscal + low capital mobility = ambiguous movement in exchange rate
expansionary monetary + restrictive fiscal + high capital mobility = depreciation of currency
Here expansionary monetary and restrictive fiscal should both work to put downward pressure on currency so why is there ambiguity as to the movement of exchange rates in a low capital mobility environment?

 

[DJS05101985]

Any econ majors out there?
This seems like it should be a straight-forward principle from economics, but I’m having trouble finding a simple explanation as to why capital flows create ambiguity in certain circumstances or favor monetary policy in others. The book itself talks about fixed exchange rates versus floating but that isn’t the same as low/high capital mobility.
So two specific questions are 1) why does expansionary monetary policy win out (depreciate the currency) over expansionary fiscal policy (which should otherwise appreciate the currency) when capital mobility is low? and 2) why does expansionary monetary policy (which should depreciate the currency) and restrictive fiscal policy (which should also depreciate the currency) have an ambiguous effect on currency when capital mobility is low?

 

[cgy5478]

with high capital mobility, capital flow is the dominant factor in determining exchange rate.
while with low capital mobility, net import/export (trade flow) is the dominant factor in determining exchange rate.
with that in mind, let’s consider 2 scenarios.
1) when capital mobility is low,
explansionary monetary policy decreases interest rate, increase aggregate demand, decreases net export, which puts downward pressure on exchange rate.
explansionary fiscal policy increases spending, which have the same eventual effect on AD and trade flows, and put further downward pressure on exchange rate.
2) when capital mobility is high,
explansionary monetary policy decreases interest rate, leads to flight of capital (capital being moved to other contries with higher rate) and puts downward pressure on exchange rate
explansionary fiscal policy increases spending, encourage borrowing, which increases insterest rates, and leads to inflow of capital which puts upward pressure on exchange rate
Therefore it’s ambigous when capital mobiltiy is high since exchange rate is being pulled from both directions.

 

[DJS05101985]

I understand now. Thanks cgy.

 

[edupristine]

when capital mobility is low then explansionary monetary policy decreases interest rate, increase aggregate demand, decreases net export, which putsdownward pressure on exchange rate and explansionary fiscal policy increases spending, which increases aggregate demand and trade flows, and put further downward pressure on exchange rate whereas,explansionary monetary policy decreases interest rate, increase aggregate demand, decreases net export, which puts downward pressure on exchange rate.