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1. Introduction The small-country Mundell–Fleming model (IS/LM/BP) explains how the exchange rate regime affects the effectiveness of fiscal and monetary policies. In this model, a change in the money supply (monetary policy) has no effect under a fixed exchange rate. In contrast, under a flexible exchange rate, the impact of a change in the money supply is magnified by the international adjustment that it causes.
1. Introduction A simple large-country IS/LM/BP model (Mundell–Fleming Model) assumes perfect capital mobility—thus, a decrease in country 1’s interest rate will cause capital to flow from country 1 into country 2, putting upward pressure on country 2’s exchange rate and downward pressure on country 1’s exchange rate (Daniels and VanHoose 2004).
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