Capital Mobility and Fiscal Policy Under Flexible Exchange Rates: An Application of Romer’s IS-MP Model
This paper applies Romer’s IS-MP model to reexamine the well-known Mundell proposition: fiscal policy is totally ineffective in changing domestic output under flexible exchange rates with perfect capital mobility. We show that the Mundell proposition is mainly based on the IS-LM framework. If the LM curve was replaced by the monetary policy function and the exchange rate affects this policy function, we further show that fiscal policy does stimulate domestic output. This indicates that the Mundell proposition is sensitive to the specification of monetary policy reaction function.
Romer’s IS-MP Model, Central Bank Reaction Function, Fiscal Policy, Capital Mobility, Flexible Exchange Rates
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