Paul Krugman: On Mundell-Fleming (Very Wonkish)

Aha. I see that Simon Wren-Lewis is on a campaign against the use of the Mundell-Fleming model, a simple international macroeconomic extension of IS-LM analysis, because of the way it handles the relationship between interest rates and exchange rates. And it’s true that the simplest version of Mundell-Fleming assumes that interest rates are equalized by capital flows, taking no account of expectations of future exchange rate changes.

But is that the way it’s taught? It’s certainly not the way the issue is handled in the leading undergraduate textbook in international economics, which for nine editions — 25 years! — has worked with an exchange rate model in which investors expect the exchange rate to revert to a long-run norm, so that you get a downward-sloping relationship between the interest rate and the price of foreign currency:

So that book, at least, has it covered.

True, I can’t speak to what people being taught this stuff from the wrong textbooks may be learning.

On Mundell-Fleming (Very Wonkish) –

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