OPEN ECONOMICS REVISITED

MUNDELL-FLEMING AND EXCHANGE-RATE

REGIME

Failasufa Azka
Faculty of Economics and Business
Syiah Kuala University
(1801102010030)

Rama Yoldha Sarah

Faculty of Economics and Business
Syiah Kuala University
(1801102010107)

ABSTRACT The Mundell-Fleming model assumes that the economy being

studied is a small open economy with perfect capital mobility. That is, the
economy can borrow or lend as much as it wants on the world financial
market and, as a result, the interest rate of the economy is determined by
world interest rates. One lesson from the Mundell-Fleming model is that
economic behavior depends on the system of exchange adopted. We begin by
assuming that the economy operates with a floating exchange rate. That is,
we assume that the central bank leaves the exchange rate adjusted for
changing economic conditions. This study examines whether economic
stability in Indonesia can be predicted by the Mundell-Fleming model.
Prediction of proxy stability of fiscal and monetary policy interactions. As
long as Indonesia's economic stability is largely determined by the strength
of economic fundamentals, while economic fundamentals are strongly
influenced by fiscal and monetary policies. Therefore flemming Mundell
predicts how strong economic stability is in Indonesia.
Keywords: Mundell Fleming, Exchange rate, Macroeconomic Stability,
Fiscal Policy, Monetary Policy.
1. INTRODUCTION
Prediction of economic stability can be seen from the stability of
macroeconomic variables on fiscal and monetary interactions. Fiscal policy
and monetary policy are integral parts of macroeconomic policies that have
targets to be achieved in the short, medium and long term. Management of
fiscal and monetary policies through good coordination will provide a
positive signal for the market and maintain macroeconomic stability.
Macroeconomic models that are often used to analyze how fiscal and
monetary policy in an open economy are the Mundell – Fleming Model. This
model is described as "a domain policy model for studying monetary and
fiscal policies in an open economy" (Mankiw, 2007). The Mundell-Fleming
model makes one important and strategic assumption, this model assumes that
the economy being studied is an open economy with perfect mobility, which
means that policies taken by the government both fiscal and monetary will
have an impact on other economic variables which disrupt macroeconomic
stability.
The Mundell-Fleming model shows that the effect of any economic
policy in a "small open economy" depends on the regime or exchange rate
system that is followed by the economy, can be fixed exchange rate regime
or flexible exchange rate regime. In other words, the effectiveness of fiscal
and monetary policies in influencing aggregate income depends on the
exchange rate regime. Under the floating or flexible exchange rate regime,
there is only an effective monetary policy. That means it can affect income.
Conversely, under a fixed exchange rate regime, only fiscal policies can affect
income.
Mundell-Fleming stated that money was a more effective policy to
increase GDP rather than fiscal policy. The findings of Mundell-Fleming can
work because they are built on the assumption by the existence of perfect flow
capital as a result of no difference in domestic interest rates and foreign
interest rates (Mankiw, 2000: 291).
Mundell-Fleming stated that money was a more effective policy to
increase GDP rather than fiscal policy. The findings of Mundell-Fleming can
work because they are built on assumptions by the existence of perfect flow
capital as a result of no difference in domestic interest rates and foreign
interest rates (Mankiw, 2000: 291).
Phenomena that occur due to the effects of fiscal and monetary policies
often cause inflation. In 2013, inflation was 8.3% due to the increase in fuel
prices. There are three stages of interaction where the response of
macroeconomic variables to shock originating from the interaction of fiscal
and monetary policies shows a unidirectional movement in the period 2000
to 2014. In the first phase of the interaction is the range 2001 to 2002, where
the increase the inflation in 2001 was 12.55%, estimated due to the increase
in fuel prices and the increase in public expenditure following the celebration
of religious holidays which are close to Lebaran, Christmas and New Year,
thus increasing demand for basic needs. The increase in inflation was
followed by a decline in GDP growth in 2001 from growth in the previous
year or a slowdown in economic growth, and also resulted in a decrease in
the growth of the money supply in 2002 which was the impact of the monetary
response to inflation, and a decline in government spending in 2002.
In the second phase of the interaction, namely the range from 2005 to
2006, where the increase in inflation in 2005 of 17.11% was estimated due to
the fiscal expansion in 2005, namely the increase in government expenditure
by 32.25% which was dominated by the increase in routine spending such as
rising salaries inflation, and also has an impact on the decline in GDP growth
in 2006 from the previous year's growth or slowing economic growth. In the
third stage of the interaction, the range from 2008 to 2009, where the 2008
inflation increased by 11.06% was estimated due to the global economic
crisis. The increase in inflation was followed by a decline in the growth of the
money supply in 2008 from the previous year's growth due to the monetary
response to the occurrence of inflation, and also resulted in a decline in
government spending in 2009 and a decline in GDP growth in 2009 from
growth in the previous year or slowing economic growth.
Indonesia, on the other hand, is a small, open economy where there are
differences between domestic and foreign interest rates, and this sometimes
makes capital flows unexpectedly. This is a conflicting point regarding
whether or not the Mundell-Fleming model can be used by Indonesia, namely
monetary policy is more effective than fiscal policy because some
assumptions are not as needed by the model.
Research that specifically predicts when stability will be achieved has not
been done much, even specifically to use the Mundel Fleming approach with
a Vector Autoregression tool that is able to predict short, medium and long
term, not yet in Indonesia. The formulation of the problem in this study is:
"Can the Mundell-Fleming model form a prediction pattern of
macroeconomic stability ?. The purpose of this study is: "Finding patterns of
prediction of macroeconomic stability by analyzing the Mundell-Fleming
model. The hypothesis in this study is: The Mundell-Fleming Model Study
can form a pattern for predicting macroeconomic stability in Indonesia.

2. THEORY
In an open economy, a macroeconomic model that is often used to
analyze how fiscal and monetary policy is the Mundell-Fleming Model,
which is taken from the last name of the inventor of the model, Robert
Mundell (1961) and Jhon Fleming (1962). This model is described as "a
domain policy model for studying monetary and fiscal policies in an open
economy" (Mankiw, 2007). policy makers often find what is happening
abroad when carrying out monetary and fiscal policies. They need to consider
developments in foreign countries even though domestic prosperity is the
only goal. The economy can be influenced by the flow of international goods
and services and international capital flows in many ways. Decision makers
who ignore this influence will face danger (Mankiw, 2007). The Mundell-
Fleming model is the IS-LM model for a small open economy.
 The Mundell-Fleming model assumes that the economy studied is a small
open economy with perfect mobility. A small open economy is an economy
that is a small part of the world economy, and does not have a significant
impact on world interest rates. With perfect mobility, it can be interpreted that
the population of a country has full access to world money markets. Due to
the assumption of perfect capital mobility, the interest rate in a small open
economy (r), must be the same as the world interest rate. This means that the
economy can borrow or lend as much as it wants on the world financial
market, and as a result the interest rate of the economy is determined by the
world interest rate (r = r*) (Mankiw, 2007).
The goods market and the IS* curve in the Mundell-Fleming model
explain that the market for onions and services is like the IS-LM model, but
in this model adds a new symbol for net exports, so the IS* curve is a curve
that shows the relationship between various levels of income and shows the
relationship of various levels of income and curricula that put the market for
goods and services. The higher the rate of eating the lower the level of
income, assuming perfect capital mobility, until r = r*, obtained by the
equation:
Y = C + I + G + NX

In Mankiw (2006) the equation is an indensity equation, that is, an

equation that must be true seen from how the equation variables are described.
In order to be more clearly seen: Comsumption is the expenditure of goods
and services by households. This consumption depends positively on
disposible income, which has a function:

C = f (Y-T)
Investment can be interpreted as goods that will be used to produce more
goods and services. Investment is the amount from the purchase of capital,
inventory and building equipment. Investment is negatively related to the
interest rate, which has a function:
I = f (r)
Government expenditure is the expenditure of goods and services by
regional scouts, centers that include wages of government work and
expenditure for the general interest, government expenditures denoted by net
exports are purchases of domestic products by foreigners (exports) minus
purchases of products overseas by citizens (import). This net export refers to
the import value minus the export value. Net exports are negatively related to
the exchange rate that has a function:
NX = f (e)
So the results of substitutions C, I, G, and NX are obtained by the IS model:
IS*: Y = C (Y-T) + I (r) + G + NX (e)
 This equation explains that income is the sum of consumption,
investment, government spending and net exports, where consumption
depends positively on disposible income, investment is negatively related to
the interest rate and net exports are negatively related to the exchange rate.
This equation is the IS* equation, which describes the balance of income and
exchange rates in the market for goods and services, (asterisks / asterisks
indicate that this equation uses the assumption of a constant interest rate at
the world interest rate r*).
The Money Market and the LM * Curve in the Mundell-Fleming model
explain that pairs of money as IS-LM. The LM* curve is a curve that shows
the relationship between the level of income at various possible interest rates
which puts money in a balance, namely the demand for money equals money
supply, with the following equation:
M / P = L (r, Y)
This equation states that supply of real money balances, M / P, is equal
to demand, L (r, Y). The demand for real money balances depends negatively
on the interest rate, and positively on Y income. Adding the assumption that
the domestic interest rate is equal to the world interest rate, the LM* equation
becomes:
LM*: M / P = L (r*, Y)
This equation shows the vertical LM * curve, because the exchange rate
does not enter into the LM* equation. Based on the world interest rate, the
LM* equation determines aggregate income, without considering the
exchange rate. The LM* curve relates the interest rate that follows the world
interest rate and income (Mankiw, 2007). From this equation, the interest rate
referred to is domestic real interest rates that follow the world interest rate
(r*), where the real interest rate is a reduction of the nominal interest rate with
inflation, and can be illustrated in the equation:
r* = (i - π)
The substitution to the above equation will produce the IS*-LM* balance
model as follows:
IS*: Y = C (Y-T) + I (i-π) + G + NX (e) LM*: M / P = L ((i-π), Y)
The IS equation describes the balance in the goods market and the LM
equation explains the balance on the money market. Balance for the economy
where the IS * curve and the LM * curve intersect. This intersection shows
the exchange rate and the level of income where the market for goods and
money is in balance. With this diagram we can use the Mundell-Fleming
model to show how aggregate income Y and exchange rates respond to
changes in policy both fiscal policy and monetary policy.
 Figure 1 Balance of the IS* Curve and the LM* Curve (Mundell-Fleming
Model)
Based on the Mundell-Fleming model image shows the equilibrium
condition of the market for IS* and the equilibrium condition of the LM*
money market. Both curves maintain a constant interest rate at the world
interest rate. The intersection of these two curves shows the level of income
and the exchange rate that meets equilibrium both in the goods market and in
the money market (Mankiw, 2007).

3. METHODOLOGY
This study uses a quantitative research approach. Quantitative research is
research that uses inferential statistics on the analysis of data that can be used
in decision making. The purpose of this analysis is to determine the degree of
relationship and the pattern / form of influence between several independent
variables with dependent variables (Rusiadi, 2018). This study discusses the
influence of economic growth variables, fiscal decentralization, labor, and
local taxes on regional inequality. The parameters observed were fiscal
monetary interactions with respect to Indonesia's macroeconomic stability
with the study of the Mundell-Fleming model, where the macroeconomic
model that is often used to analyze how fiscal and monetary policy in an open
economy is the Mundell-Fleming Model. These parameters are; fiscal policy
on tax revenues and government expenditures, monetary policy variables
namely interest rates and money supply, and macroeconomic stability
variables, namely gross domestic product, investment, exchange rate and
inflation.
This study focuses on fiscal and monetary policies on Indonesia's
macroeconomics during the period 2000-2014. In this study using one
secondary data obtained from International Financial Statistics, issued by the
International Monetary Fund (IMF), Bank Indonesia, and BPS. The analysis
model used is simultaneous regression analysis to determine the level of
correlation and the effect that occurs with at least two stages of the quadratic
method. The research model used is a simultaneous equation model estimated
using the Two Stage Least Square (TSLS) Method.
IS Equation Block
Yt = ao + ba1Ct + a2It + a3Gt + a4Xt - a5IMt ……………………… (1.1)
Ct = bo + b1Yt + b2To ……………………… (1.2)
It = co - c1Rt + c2Yt ……………………… (1.3)
Gt = Go ……………………… (I.4)
Xt = Xo ……………………… (1.5)
Mt = fo + f1Yt - f1Kurst ……………………… (1.6)

LM Equation Block
Ms = Md ……………………… (1.7)
MSt = Mso ……………………… (1.8)
Mdt = ho - h2Rt + h3Yt ……………………… (1.9)

BOP Equation Block

BoPt = jo + j1KURSt + j2DIFFRt ……………………… (1.10)

IS Curve Equation Model

Based on the results of the previous equations that were formed to form IS,
the IS equation can then be calculated as follows:
Yt = Ct + It + Gt + Xt + Mt
Yt = Co + cYt + Io - blntt + Go + Xo - (Mo + mYt - zKurst)
Yt = Co + cYt + Io + Go + Xo - Mo - mYt + zKurst - blntt
A = C0 + I0 + G0 + X0 – M0 + zKurst; that , Yt = α ( A – bInt)

In which:
Y : Gross Domestic Product;
C : Total Consumption;
I : Total Investment;
G : Total Government Expenditure asta;
X : Total export;
M : Total import;
Int : Interest Rate;
Kurs : Exchange rate;
c : Coeffisien variable GDP at consumption equation;
b : Coeffisien variable interest rate at investment equation;
m : Coeffisien variable GDP at import equation;
z : Coeffisien variable exchange rate at import equation;
t : time
LM Curve Equation Model
Balancing Money market when Ms = Md, therefore the LM equation is;
Mso = Mdo + kYt – hIntt
kYt = Mdo – h Intt – Mso
kYt = Mso – Mdo + h Intt

In which:
Ms : Supply of money;
Md : Demand of money;
k : Coeffisien variable GDP at demand of money equation;
h : Coeffisien variable interest rate at demand of money equation

Fiscal Policy Multiplier

Fiscal policy multipliers show the extent to which increased government
spending can change the level of equilibrium income, assuming that
monetary policy is constant. Fiscal Policy Multipliers (MKF) in Indonesia
can then be calculated as follows (Dornbusch, 1994):

ℎ𝑎
MKf =
ℎ+𝑘𝑏𝑎
Monetary Policy Multiplier
Monetary policy multipliers show the extent to which the amount
distributed in real money can increase equilibrium income levels, without
changes in fiscal policy. The Fiscal Monetary Multiplier (MKF) in Indonesia
Indonesia can then be calculated as follows:

ba
MKm =
h+kba

4. RESULTS AND DISCUSSION

Based on the results of the analysis of Forecast Error Variance Decomposition
(FEVD), it is known that there are several interactions that occur between
fiscal policy and monetary policy towards macroeconomic stability. The
interaction of fiscal and monetary policy variables can be seen from the
Variance Decomposition describing more effective policy variables on
macroeconomic variables.

Fiscal policy
In fiscal policy, the main indicator is the State Budget (APBN) (Raharja and
Manurung, 2001). During the 1997/1998 budget the increase in government
spending was 63% higher than the previous year. The government policy
affected economic growth where at the time it was the beginning of a crisis
economy. The same thing happened in 2002/2003 where the budget reached
85% higher than the previous year.
Economic activity will increase if government spending increases, but there
is a threat of economic instability in Indonesia in the form of a threat of
inflation which will be difficult to avoid. The state budget is considered a
locomotive for economic growth because it is based on the belief that the
government economy is needed for the implementation of the trilogy
development, namely: growth, equity, and stabilization. This trilogy is the
realization of fiscal function theory, namely the allocation of public goods
(allocation), income distribution (distribution), and economic stabilization
(stabilization).
The economic crisis that occurred in Indonesia in 1997 prompted the
government to increase spending. Banking restructuring costs and the
recovery of the real sector have led the government to increase the budget
deficit given the limited resources available. Or, the budget deficit greatly
increased after the 1997 crisis, especially in the period of the 1999 state
budget which reached Rp. 114585 billion. On the other hand, Bank Indonesia
implemented a monetary policy contract to fend off inflation and control the
money supply. At that time, interest rates were very high, 25% in 1998 and
an average of 22% in 1999.
On the other hand, fiscal policy does not deliver the expected results,
because it is not only fiscal policy that can affect the Indonesian economy,
but also monetary policy controlled by the monetary authority. In many cases
fiscal and monetary policies often cause the opposite effect or crowding out
which results in the need for an appropriate coordination mechanism in
Indonesia with the aim of economic development in order to achieve it.

Monetary policy
Price and exchange rate stability are requirements for economic recovery
because the economic activities of the community, business sector and
banking sector will be hampered without them. Therefore, it is only natural
that the main focus of Bank Indonesia's monetary policy during this economic
crisis is to achieve and maintain price stability and the rupiah exchange rate.
Law number 23 of 1999 concerning Bank Indonesia clearly states that
the objective of Bank Indonesia is to achieve and maintain the stability of the
rupiah exchange rate in Indonesia which has a sense of price stability and
stability in the rupiah exchange rate.
To achieve this goal, recently, Bank Indonesia implemented a monetary
policy framework based on controlling the provision of money. Therefore,
Bank Indonesia has sought to control base money as the operational target of
monetary policy.
By using the monetary policy framework as described above, Bank
Indonesia in the early period of the economic crisis, especially during 1998,
implemented tight monetary policy to restore monetary stability. This tight
monetary policy is reflected in the annual growth of the target of the money
supply which continued to be suppressed from the highest level of 30.13% in
2000 to 9.58% in 2001. Strict monetary policy must be done because in the
inflation expectation period in 2008 the number of people was very high and
the money supply is increasing rapidly.
 As long as high inflation and the level of risk in holding the rupiah, efforts
to slow the rate of growth in the money supply have supported domestic
interest rates. Furthermore, the high interest rate is needed to make people
want to hold the rupiah and not spend things that are not urgent.

Trade policy
International Trade Policy is a policy carried out by a country in the form of
an action or regulation that affects directly or indirectly the structure,
composition and direction of international trade from that country and a series
of actions to be taken to overcome difficulties or problems in international
trade relations to protect national.

Exchange rate
An exchange rate is the price of a currency against another currency or
the value of a currency against the value of another currency. An increase in
domestic currency exchange rates is called an appreciation of foreign
currencies. The decline in the domestic exchange rate is called depreciation
of foreign currencies. Factors affecting the exchange rate are the relative
inflation rate, relative income level, relative interest rate, government control,
expectations. According to Madura (2003: 111-123), to determine changes in
exchange rates between currencies of a country is influenced by several
factors that occur in the country concerned namely the difference in inflation
rates, the difference in interest rates, the difference in GDP growth rates,
government intervention in the currency market foreign and market estimates
of future currency values.

Fixed Exchange Rate

An exchange rate system where the value of a currency is maintained at
a certain level against a foreign currency. If the exchange rate moves too
large, the government intervenes to return it. This system began to be
implemented in the post-World War II era which was marked by the release
of a conference on the exchange rate system held at Bretton Woods, New
Hampshire in 1944.

Floating Exchange Rate

After the collapse of the Fixed Exchange Rate System a new concept
emerged, namely the Floating Exchange Rate System. In this concept the
exchange rate is allowed to move freely. The exchange rate is determined by
the strength of the demand and supply of the currency on the money market.
The fact that occurs in many countries in the world adheres to the variance of
the two basic systems of exchange rates above. There are six exchange rate
systems based on the size of the intervention and the outlook of foreign
exchange held by a country's central bank that is used by many countries in
the world. Because the central bank does not interfere in the foreign exchange
market with flexible exchange rates, it causes no assets to be traded and does
not need to distinguish the impact period and full equilibrium.
 The following are the results of data analysis and discussion in figure 2
and table 1.

Table 1 Prediction Pattern of Macroeconomic Stability in the Mundell-

Flemming Model

Monetary fiscal prediction pattern towards macroeconomic stability as

follows:

Predictions of Monetary Fiscal Interaction Against GDP

Fiscal and monetary interactions that most affect GDP are monetary
policy in the short, medium and long term. In the short term fiscal and
monetary interactions with GDP are controlled by monetary policy through
controlling lending rates so that they are more effective. In the medium and
long term fiscal and monetary interactions with GDP are more effectively
controlled by monetary policy through controlling the money supply.
Effectiveness can be interpreted as a policy of controlling credit interest rates
and the money supply is more effective in increasing output or economic
growth compared to the policy of tax revenues and government spending.
Monetary policy by reducing lending rates will directly encourage investment
so that it will increase GDP, while increasing the money supply will increase
the ability of people to transact in the short term and invest in medium and
long-term steps that will encourage economic growth.
This research is in accordance with Santoso (2009) research that
monetary policy has more influence or positive impact on GDP than fiscal
policy. The less influential variable of government expenditure is in
accordance with Mundell-Fleming's hypothesis, that expansionary fiscal
policy will lead to Crowding Out Effect which confirms the impact of fiscal
policy on decreasing GDP due to rising interest rates.

Predictions of Monetary Fiscal Interaction Against Investment

The effectiveness of fiscal and monetary interactions that most influence
investment, both in the short, medium and long term is fiscal policy. In the
short, medium and long term fiscal and monetary interactions with
investments are more effectively controlled by fiscal policy through tax
revenues.
Effectiveness means that policies on tax revenues and government
expenditure are more effective in increasing investment compared to policies
on loan interest rates and the money supply. Rising tax revenues will lead to
an increase in government spending, especially on capital expenditures that
encourage investment growth. Thus this illustrates that the increasing
government expenditure, investment increases.
The results of this study are in accordance with Eisner's (1989) research
on the American economy in the period 1956-1984 obtaining evidence that
fiscal policy through government spending has a positive effect on
investment.

Predictions of Monetary Fiscal Interaction Against Exchange Rates

The effectiveness of fiscal and monetary interactions that most affect the
exchange rate, both in the short, medium and long term, is fiscal policy. In
the short, medium and long term fiscal and monetary interactions with the
exchange rate are more effectively controlled by fiscal policy through
government spending.
This effectiveness means that policies on tax revenues and government
spending are more effective in maintaining exchange rate stability compared
to credit interest rates and the money supply. Expansive fiscal policy will
increase production capability through increased investment. Rising
production that drives exports will strengthen the position of the rupiah
exchange rate.
In an open economy, fiscal policy also influences exchange rates and the
trade balance. In the case of fiscal expansion, interest rate increases due to
government loans attract foreign capital. In their efforts to get more dollars
for foreign investment bids up to the dollar price, causing exchange rate
appreciation in the short term
 According to Santoso (2009) Fiscal policy through fiscal expansion, for
example by increasing government spending and lowering taxes will shift the
IS curve to the right and the increase causes the interest rate to rise. When the
domestic interest rate is higher than the international interest rate, there will
be capital inflows. This flow of funds will increase domestic demand for the
domestic currency in the foreign exchange market, thereby increasing the
exchange rate of the domestic currency. The appreciation of this exchange
rate makes the domestic currency relatively more expensive to foreign
products, this reduces net exports. The existence of fiscal policy in the sense
of an increase in government spending (expansionary fiscal) will move the IS
curve to the right. As a result, domestic interest rates have increased and
capital inflows have occurred internationally. With a flexible exchange rate
policy, the increase in demand for the Rupiah will allow changes in the
exchange rate which causes the Rupiah exchange rate to increase
(appreciation of the Rupiah).

Predictions of Monetary Fiscal Interaction Against Inflation

The effectiveness of fiscal and monetary interactions that most influence
inflation, both in the short, medium and long term is monetary policy. In the
short, medium and long term fiscal and monetary interactions with inflation
are more effectively controlled by monetary policy through controlling
interest rates. Effectiveness means that the policy of controlling credit interest
rates and the money supply is more effective in maintaining inflation stability
compared to the policy of tax revenues and government spending. Monetary
policy by reducing lending rates has the effect of transferring the use of
money for consumption to investment, thereby reducing the money supply
which will encourage stable inflation.
Abel (2002) monetary policy is used to carry out economic stabilization
in the short term while fiscal policy is directed towards achieving medium
and long-term economic targets. Meanwhile, monetary policy in the long term
can be focused on maintaining inflation. Monetary policy is directed at
achieving a balance between money demand and supply. The balance in the
money market will affect the balance in the goods market. If the amount of
money in circulation is more than what is needed, it will increase the demand
for goods and services which will increase inflation (Madjid, 2007).
After analyzing the interaction of fiscal and monetary policies on
macroeconomic stability above, the authors conclude that monetary policy is
more effective than fiscal policy in maintaining macroeconomic stability in
Indonesia, this is because monetary policy through interest rates and the
money supply in the short term and the long term is able to maintain inflation
and increase economic growth, where an increase in the money supply
(monetary expansion) leads to increased demand, as a result domestic interest
rates decline and capital outflows from the international world so as to reduce
the exchange rate of the domestic currency (exchange rate depreciation) this
can cause exports to increase which has an impact on rising incomes, this is
in accordance with Mundell-Fleming's theory which explains the impact of
monetary policy on increasing income, as follows:

In the picture above, showing an increase in the money supply (monetary

expansion) shifts the LM * curve to the right which decreases the exchange
rate and increases income. The depreciation of the exchange rate makes
domestic goods relatively cheap to foreign goods and increases net exports.
The increase in net exports adds to the impact of monetary policy on
increasing income (Mankiw, 2007). While fiscal policy becomes less
effective in increasing economic growth, this is due to an increase in
expenditure (fiscal expansion) leading to increased demand, as a result of
which domestic interest rates have increased and capital inflows have
occurred internationally so as to increase the exchange rate of the domestic
currency (appreciation rate), Appreciation of this exchange rate can cause
exports to decline which results in a decline in income, this is in accordance
with the Mundell-Fleming theory which explains the impact of fiscal policy
on decreasing income, as follows:

In the above, indicating an increase in government spending (fiscal

expansion) causes the IS * curve to shift to the upper right, this increases the
exchange rate but has no effect on income. The appreciation of the exchange
rate makes the domestic currency relatively expensive for foreign products,
thereby reducing net exports. The decline in net exports reduces the impact
of fiscal policy on income.

5. CONCLUSIONS AND SUGGESTIONS

Conclusions
The Mundell-Fleming model is the IS-LM model for small economies,
where the price level is certain and then shows the causes of fluctuating
income and exchange rates.
This Mundell-Fleming model predicts international variables such as
exchange rates that can affect economic performance and shows how
international interactions can change the impact of monetary and fiscal
policies that affect income.
The Mundell-Fleming model shows that fiscal policy cannot affect
aggregate income under a floating exchange rate. But fiscal policy affects
aggregate income under a fixed exchange rate. And conversely monetary
policy cannot affect aggregate income under a fixed exchange rate. But fiscal
policy affects aggregate income under a floating exchange rate.
Fixed and floating exchange rates, each of which has advantages.
Floating exchange rates make monetary policy makers free to pursue goals
other than exchange rate stability. While the fixed exchange rate lowers some
of the uncertainty in international business transactions.

Suggestions
1. Facing the issue of output shock and inflation shock, the need for
coordination of fiscal and monetary policies in an integrated manner to make
it more useful, compared to without coordination. Coordination of fiscal and
monetary policies must be increased so that institutional strengthening occurs
such as the establishment of a fiscal / monetary council. With the mix of these
two policies will strengthen these institutions, (fiscal and monetary
coordination councils) and finally be able to increase macroeconomic
stability in Indonesia, as an expectation.

2. The mix of fiscal and monetary policy interactions in Indonesia has not
been effective so far that it is problematic when facing inflation shocks,
coordination of fiscal and monetary policies in being able to combat
inflationary pressures from the supply side needs to be increased. In addition,
policy coordination is needed in controlling production (especially the
availability of food) for meeting people's needs.
6. REFERENCES
Nurjannah Rahayu, Phany Ineke Putri. 2016. Mundell-Fleming Model: The
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