Question

What would happen to the rate of interest, in new equilibrium, if the money supply rises in the Mundell-Fleming model under the flexible exchange rate and absolutely free capital mobility, if the international interest rate remains the same?

• A. It will rise.
• B. It will fall.
• C. It would either rise or fall.
• D. It would remain constant.

Hint:

What role does free capital mobility have on interest rates?

Answer 1

The Correct Option is D

Within the *Mundell-Fleming model*, given perfect capital mobility and a flexible exchange rate, an expansion of the money supply does not alter the interest rate.

This is because unhindered capital movement equalizes domestic and international interest rates, thereby keeping the interest rate constant.

Hence, the correct answer is (d).