Page 259 - DECO402_Macro Economics

Macroeconomic Theory

Notes Criticism of Mundell’s Model
But there are some shortcomings of this analysis:
1. Unrealistic Assumptions: This model assumes that officers know the limit at which economy
is far from both the internal and external balance so that appropriate monetary and fiscal
policy may be used. This is also assumed beforehand that they know quantitative results
which are possible by the use of each policy. But these assumption are far from reality,
because it is not possible to correctly judge the category of imbalance. Hence changing the
policy may not be appropriate for such imbalance.
2. Overlook of Unemployment and Inflation: This analysis overlooks unemployment and
inflation. It is unreal, because this concept which is known by the name of stagflation is often
found in all developed countries.
3. Neglect of other Factors: This analysis only thinks over difference in interest rates a reason
for capital momentum and ignores other factors such as exchange rate changes. Other than
this it is not possible that continuous deficit is financed by capital momentum.
4. Practical Constraints of Monetary and Fiscal Policies: Monetary and Fiscal policies work
under a definite practical constrainte of political reasons, some governments are not able to
follow restrictive fiscal policy and monetary policy with high interest rates. Though such
policies may be started, but they cannot be successful, because capital flow cannot be interest
sensitive.
5. Unsuccessful Prescribed Policy Mix: Prescribed policy mix cannot be successful in correcting
current account deficit because policy mix influences both- capital flow and imports, which
is why it only ensures that negative business balance is compensated by positive capital
flow and also vice versa.

Task Expresses your thoughts in relation to the Mundel’s Model

6. Not True Adjustment Mechanism: Monetary-Fiscal mixture is not a true adjustment
mechanism. It does not adjust balance of payment but only makes it stable. Capital flow,
leaving the prices and income unchanged, only completes the gap between the sovereign
demand and supply of foreign exchange.
7. No Consideration on the Debt Servicing Requirements: This analysis does not make
consideration on Debt servicing Requirements because, when domestic interest rates are
increased then, continuous capital flow will happen on the current account of balance of
payment.
8. Decrease in investments at home: When interest rates are increased by the medium of
monetary policy, it will bring a decrease in domestic investment. It should definitely be
accompanied by either a decline in government expenditure or tax cut or by any composition
of the two. Such monetary- fiscal policy mixture misuses the savings of the economy by
turning them towards debt financed government expenditure, which stops capital building.
According to Johnson, “It creates the problem of ‘ineptitude vs proficiency’ in use of domestic
savings possibility”
9. Conflicts between Prescribed Policy Mixes: There is a possibility of inter conflict between
the prescribed policy mixes of governments of various countries. Johnson has told, “In all
countries together reach the right combination of monetary and fiscal policies, particularly

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