In the Mundell-Fleming model:
A) the exchange rate system must have a floating exchange rate.
B) the exchange rate system must have a fixed exchange rate.
C) it makes no difference whether the exchange rate system has a floating or a fixed exchange rate.
D) the behavior of the economy depends on whether the exchange rate system has a floating or fixed exchange rate.

Question

Quizplus · Accepted Answer

The behavior of the economy in the Mundell-Fleming model depends on whether the exchange rate system has a floating or fixed exchange rate. In a fixed exchange rate system, the central bank must use monetary policy to maintain the exchange rate, which limits its ability to use monetary policy for other purposes. In a floating exchange rate system, the central bank can use monetary policy to stabilize the economy without affecting the exchange rate. Therefore, the choice of exchange rate system affects the way in which monetary policy works in the model.

In the Mundell-Fleming Model