In the Mundell-Fleming model, if political turmoil raises the risk premium in a country's interest rate, then the exchange rate will ______.

Question

Quizplus · Accepted Answer

According to the Mundell-Fleming model, an increase in the country's risk premium will shift the capital outflow in the capital account curve to the left, reducing the supply of capital and leading to a higher interest rate. As a result, the currency will depreciate in order to maintain the balance of payments. Therefore, the exchange rate will decrease.

In the Mundell-Fleming Model, If Political Turmoil Raises the Risk