Mundell, the father of the Euro, says for a shared currency, business cycles should be in sync, workers should be able to move freely within borders to even out labor demand, and wages and prices should be flexible so differences in competiveness can be corrected. China’s rise altered the correlation of the Eurozone economies, as Germany benefited from demand for high-end specialty machines, while Spain and Portugal suffered to compete with China at low-end manufacturing, having locked themselves into high wage commitments through pensions and labor laws.
A problem has been with the policy mix in Japan, which has emphasized fiscal expansion combined with monetary tightness. Fiscal expansion coupled with a high degree of capital mobility and a flexible exchange rate has kept the yen overvalued, reduced the current account surplus, and built up the largest public debt level in the history of any country. As the Mundell–Flemingmodel suggests, fiscal policy combine with monetary tightness does not work to stimulate employment and output; the multiplier is zero.
The deregulation of Mundell–Fleming flows appearing as the least politically costly response to changing comparative advantage induced easy money and endogenized credit allocation which promptly financed asset price imbalances in favour of non-tradables. The latter dictated the allocation of borrowed resources that made the financial crisis inevitable.
The real exchange rate in Slovakia is negatively associated with real M2, the US Treasury bill rate, country risk, and the expected inflation rate and positively influenced by deficit spending/GDP ratio and the stock price index. The behaviour of error variance can be captured by the GARCH process.
Furthermore, the model, predicts that fiscal policy is totally ineffective. A fiscal expansion leads to a large external surplus and hence appreciation of the exchange rate sufficient to crowd out an amount of net exports equivalent to the fiscal stimulus, so as to leave the level of income unchanged.
According to the Mundell-Fleming model, an open economy with a flexible exchange rate and perfectly mobile capital is completely insulated from foreign shocks, except from changes in interest rates. Any increase in foreign income or prices cause an appreciation of the domestic currency sufficient to neutralize the initial positive effects on net exports and leave national income unchanged.
Although the Mundell-Fleming model has remained highly influential in both academic and policy circles, developments in macroeconomics beginning in the late 1970s questioned the use of models in which the underlying preferences and technology were not fully specified and long-run budget constraints were not satisfied. They argue that to understand short-run macroeconomics in the open economy, it is important to move beyond the Mundell-Fleming model toward a dynamic, utility-maximizing framework, where long-run budget constraints are satisfied.
Mundell shows that under floating exchange rates, positive monetary policy innovations tend to have a "beggar-thy-neighbor" effect, raising domestic output but, through the effect of real depreciation, lowering foreign output. On the other hand, fiscal policy shocks tend to increase output in both countries.
The Mundell-Fleming model of international macroeconomics originated in the writings of Robert A. Mundell and J. Marcus Fleming in the early 1960s. The key contribution of the model has been a systematic analysis of the role played by international capital mobility in determining the effectiveness of macroeconomic policies under alternative exchange rate regimes.
With full stock/flow accounting respected, the two-country open economy portfolio balance model has just two independent equations for asset market clearing. It can determine home and foreign interest rates but not the exchange rate. If asset market equilibria vary smoothly over time, the balance of payments equation in the Mundell–Fleming model is not independent and cannot set the exchange rate either.