Mundell's academic contribution

Professor Mundell's great contributions to economics:

First, the theoretical Mundell-Fleming model of macro-stability policy under open conditions;

the second is the theory of optimal currency region. Professor Mundell keenly observed that from the 196s to the present, a remarkable feature in the development of world economy is that with the development of world economic integration and globalization, products, services, especially capital can flow across borders on a large scale through trade and investment. In a more open economic system, a country's monetary sovereignty and fiscal policy effect are more restricted by the outside world, and its macro-control ability is declining. It is increasingly difficult for economics to predict the economic prospect. One of the important reasons is that traditional macroeconomics and microeconomics are facing new challenges under the conditions of economic globalization.

In the field of international finance, he is a great forerunner and prophet. The Royal Swedish Academy of Sciences said in the award announcement: Professor Mundell laid the cornerstone of monetary and fiscal policy theory in an open economy ... Although decades have passed, Professor Mundell's contribution is still outstanding and constitutes the core content of international macroeconomics teaching.

The reason why Mundell's research has such an important influence is that he chose the topic almost on the basis of accurately predicting the future development direction. In the 196s, the pattern of international monetary arrangement was that all countries had their own set of currencies, and almost all scholars thought it was necessary and natural. The degree of opening up the international capital market is also quite low. It is in this situation that Mundell raised the question ahead of reality: what will be the result of monetary and fiscal policies related to the integration of international capital markets? How will these results depend on whether a country adopts fixed exchange or free exchange? Should every country have its own set of currencies? After asking and answering such questions, Mundell transformed the macroeconomic theory in the open economy. His most important contribution was made in the 196s. By the second half of 196s, Mundell was a leading figure in the academic circles of the University of Chicago. Many of his students at that time have now become fruitful researchers in the field he laid the foundation for.

In several papers published in the early 196s, Mundell developed the analysis of monetary and fiscal policies (i.e. stability policies) in an open economy. He discussed the short-term effects of monetary and fiscal policies in an open economy in Capital Flow and Stability Policy under Fixed and Flexible Exchange Rates (1963). The analysis was simple, but the conclusion was rich, novel and clear. In this epoch-making paper, Mundell introduced foreign trade and capital flow into the traditional IS-LM model (which was developed by Hicks, a Nobel laureate in economics in 1972, to analyze the closed economy), and clarified that the effect of stabilization policy will change with the degree of international capital mobility. In particular, he demonstrated the significance of the exchange rate system: monetary policy is more powerful than fiscal policy under floating exchange rate, but the opposite is true under fixed exchange rate.

we can think of it this way, assuming that capital has high liquidity and foreign and domestic interest rates are the same. Then under the fixed exchange rate, the central bank must intervene in the circulation market to meet the public's demand for foreign currency circulation under this exchange rate. As a result, the central bank will lose control of the money supply and have to passively adjust the money supply to meet the money demand (domestic circulation). The central bank's attempt to implement a single national monetary policy through so-called open market operations will also be ineffective, because neither interest rates nor exchange rates can be affected. However, if government expenditure or other financial measures are increased, national income and domestic economic vitality can be improved, thus avoiding rising interest rates and strong exchange rate obstacles.

let's look at the floating exchange rate. Floating exchange rate is the exchange rate determined by the market, that is, the central bank's intervention in the circulation field will be limited. Fiscal policy is not very powerful. Under the condition of unchanged monetary policy, increasing government expenditure will lead to greater demand for money and a tendency to pursue high interest rates. The inflow of capital will strengthen the exchange rate of areas with low net exports after removing the full expansion effect of high government expenditures. However, monetary policy under floating exchange rate will become a powerful tool to affect economic vitality. Expanding the money supply often raises lower interest rates, leading to capital outflows and a weaker exchange rate, which in turn can increase net exports and promote economic expansion.

floating exchange rate and high capital liquidity reveal the current monetary system in many countries. However, in the early 196s, almost all countries were linked by the fixed exchange rate of the Bretton Woods system. Therefore, analyzing the consequences of floating exchange rate and high capital mobility is just like satisfying academic curiosity. Why did this curiosity happen to Mundell? This may be related to Mundell's birth in Canada, because in the 195s, Canada began to deregulate and allowed its currency to float in line with the US dollar. With the opening of the international capital market and the collapse of the Bretton Woods system, Mundell's foresight is closely related to the next decade. Different from other researchers in the same period, Mundell's research did not stop at short-term analysis. He made a dynamic study of money, and monetary dynamics is the key theme of several important papers. He emphasized that the adjustment speed of products and capital markets is different (this is called the principle of effective market classification). Later, his students and others paid attention to this issue and explained how the exchange rate was temporarily overshoot under some interference factors.

an important issue is related to the deficit and surplus in the compensation balance sheet. During the post-war period, the study of these imbalances was based on static models and emphasized the real economic factors and foreign trade flows. Thanks to David Humes' classic international price adjustment mechanism, which pays attention to monetary factors and stock, Mundell uses a dynamic model expressed by formula to reveal how the persistent imbalance will appear and how to make it disappear. He demonstrated that as the monetary assets (also its property) held by the private sector are exchanged for surplus or deficit, the economy will gradually adjust over time. For example, at a fixed exchange rate, when capital flows are slow, an expanded monetary policy will lower interest rates and boost domestic demand. Subsequently, the deficit in the compensation balance sheet will produce currency outflow, which in turn will reduce demand until the compensation balance is balanced. This method, adopted by many researchers, has become a well-known monetary method of compensation balance. For a long time, it has been regarded as a long-run benchmark to analyze the stability policy in an open economy. This view has been frequently applied to the practical work of economic policy-making, especially to IMF economists.

Before Mundell, the stability policy was not only static, but also assumed that all the economic policies of a country were adjusted and combined by a single hand. As a contrast, Mundell used a simple dynamic model to examine how fiscal policy and monetary policy move towards their own goals, external and internal balance, so as to drive the economy to approach the goals over time. This means that two different authorities-the government and the central bank-will assume their respective responsibilities for their stability policy tools. Mundell's conclusion is straightforward: to prevent economic instability, the relationship between policy and economic life should be consistent with the efficacy of the two tools. In his model, monetary policy is linked to external balance, and fiscal policy is linked to internal balance. Mundell's initial concern was not the separation of monetary and fiscal policies, but the explanation of the conditions of separation. He took the lead in thinking that the central bank should be independently responsible for price stability, and this idea was widely accepted later.

Mundell's contribution has been proved to be a watershed in international economics research. They introduce the dynamic method, and on the basis of clearly distinguishing stock and flow, analyze their interaction in the process of economic adjustment towards long-term stability. Mundell's research also reconciles the short-term analysis of Keynesians with the long-term analysis of classical economics. Later researchers expanded Mundell's achievements. This model is extended to include the expected decisions of households and enterprises, alternative financial assets and more dynamic current account and price adjustment. Despite these amendments, most of Mundell's conclusions have stood the test.

From the short-term and long-term analysis conducted by Mundell, we can also get the basic conclusions about the conditions of monetary policy. Under the condition of a. free capital flow, monetary policy can be directed to both B. external goals-such as exchange rate-and C. internal (domestic) goals-such as price level-but they are not carried out at the same time. This contradictory trinity is self-evident to theoretical economists. Today, these insights are also shared by most participants in practical debates. Fixed exchange rate occupied the mainstream position in the early 196s. A few researchers have discussed the advantages and disadvantages of floating exchange rate, but they all think that a country's currency is necessary. In 1961, Mundell put forward the problem of optimal currency area in his paper, which seems a little radical: when will it be more favorable for several countries or regions to give up their respective monetary sovereignty and agree with the same currency? Mundell's paper briefly mentioned the advantages of the same currency, such as lower transaction costs in trade and less uncertainty about related prices. These benefits were later described more. The biggest disadvantage is that it is difficult to maintain employment when demand changes or other asymmetric shocks require a specific region to cut real wages. Mundell stressed that in order to offset these disturbances, it is very important for the labor force to have high mobility. Mundell described such an optimal currency region, where the migration tendency between countries and regions is high enough to ensure that a certain region can still achieve full employment through labor mobility when facing asymmetric shocks. Other researchers have expanded this theory and determined additional standards, such as capital flow, regional specialization, and the same taxation and trade system.

Mundell's thinking decades ago seems to be closely related to today. Due to the increasing capital mobility in the world economy, the exchange rate is becoming more and more fragile under the once fixed but now adjustable exchange rate system; Some areas are involved in this problem. Many observers believe that a country must choose between currency union or floating exchange rate (two situations discussed in Mundell's paper). Needless to say, Mundell's research also influenced the combination of the euro. After weighing the pros and cons, EMU researchers adopted the idea of optimal currency regional economy as a new prescription. Even, the key issue here is labor mobility to cope with asymmetric shocks. Mundell also made other contributions to macroeconomic theory. For example, he pointed out that higher inflation will make investors reduce their cash balance to increase real capital. As a result, the expected inflation can also have a real economic effect-the well-known Mundell-Tobin effect. Mundell also made a lasting contribution to the theory of international trade. He explained how international capital and labor flows can make commodity prices equal between countries, even when foreign trade is restricted by trade barriers. This can be regarded as a mirror image of the well-known Huxhill-Olin-sammer conclusion, which holds that the free trade of goods often leads to the equal remuneration of capital and labor between countries, even if international capital flow and immigration are restricted. These results clearly show that trade barriers will stimulate the international flow of capital and labor, and in turn, immigration and capital flow barriers will stimulate commodity trade.