Suppose, in the basic Mundell-Fleming diagram that plots the internal balance (IB) and external balance (EB) schedules against the interest rate (i) and government spending minus taxes (G - T), that the economy is located at a point that is above (or to the left) of the IB schedule and also above (or to the left) of the EB schedule. In this situation the economy is experiencing
A) unacceptably high unemployment and a balance-of-payments deficit.
B) unacceptably high unemployment and a balance-of-payments surplus.
C) unacceptably rapid inflation and a balance-of-payments deficit.
D) unacceptably rapid inflation and a balance-of-payments surplus.

Question

Quizplus · Accepted Answer

Being above or to the left of both the IB and EB schedules in the Mundell-Fleming model indicates that the economy is experiencing high unemployment (indicating that the economy is not at internal balance) and a balance-of-payments surplus (indicating that the economy is not at external balance). This is because the IB schedule represents the combination of fiscal policy (G - T) and interest rates that would achieve full employment without inflation, and the EB schedule represents the combination that would achieve a balance in international payments. Being above these schedules suggests that the economy is not producing at full capacity (hence high unemployment) and that it is exporting more than it is importing (hence a balance-of-payments surplus).

Suppose, in the Basic Mundell-Fleming Diagram That Plots the Internal