Global finance 431 might be called the Mundell-Fleming conditions,taken from the most influential approach to payments balance developed in the early 1960s.4 These conditions include the possibility that financial assets may be fully mobile across borders.(In what follows,I use"capital mobility"to mean the mobility of financial capital,as does the literature in question.) Simply put,the Mundell-Fleming approach indicates that a country can have at most two of the following three conditions:a fixed exchange rate,monetary policy autonomy,and capital mobility.Without capital mobility,national authorities can adopt and sustain a monetary policy that differs from the policies of the rest of the world and can hold their exchange rate constant; however,with mobile capital,the attempt will be contravened by financial flows.Assume the authorities want an expansionary monetary policy.Without capital mobility,a fall in interest rates will lead to a rise in demand,and the economy will be stimulated (we ignore longer-term effects on the payments balance).With capital mobility,reduced domestic interest rates will lead to an outflow of capital in search of higher interest rates abroad,and long before monetary policy has a real effect,interest rates will be bid back up to world levels.is The reason for the result is straightforward:if capital is fully mobile across borders,interest rates are constrained to be the same in all countries and national monetary policy can have no effect on national interest rates. However,to go back to the original conditions,if capital mobility is given (or imposed),monetary policy can be effective if the value of the currency is allowed to vary.Monetary policy operates,in other words,via exchange rates rather than via interest rates as in a typical closed-economy model.With capital mobility,monetary expansion greater than that in the rest of the world causes a financial outflow in which investors sell the currency;the result is currency depreciation.Depreciation in most cases stimulates the economy as prices of foreign goods rise relative to prices of domestically produced goods,thereby increasing local and foreign demand for locally produced goods.6 A parallel story can be told about fiscal policy.If capital is not mobile and the exchange rate is fixed,expansionary fiscal policy raises national interest rates as the government finances increased spending by floating more bonds.The 14.See the following works of Robert A.Mundell:"The Appropriate Use of Monetary and Fiscal Policy Under Fixed Exchange Rates,"IMF Staff Papers 9(March 1962),pp.70-77;"Capital Mobility and Stabilization Policy Under Fixed and Flexible Exchange Rates,"Canadian Journal of Economics and Political Science 29 (November 1963),pp.475-85;and"A Reply:Capital Mobility and Size,"Canadian Journal of Economics and Political Science 30 (August 1964),pp.421-31.The basic model can be found in any good textbook discussion of open-economy macroeconomics;a useful survey is W.M.Corden's Inflation,Exchange Rates,and the World Economy,3d ed.(Chicago: University of Chicago Press,1986). 15.The argument presented here is in simplified form.Variation in monetary autonomy is actually along a continuum,not dichotomous:the choice is not starkly between full monetary independence and none at all;it is instead among different degrees of autonomy. 16.This ignores the potential contravening effects of the depreciation on national income;that is,it assumes that substitution effects dominate income effects or that expenditure switching dominates expenditure reduction.Global finance 431 might be called the Mundell-Fleming conditions, taken from the most influential approach to payments balance developed in the early 1960s.14 These conditions include the possibility that financial assets may be fully mobile across borders. (In what follows, I use "capital mobility" to mean the mobility of financial capital, as does the literature in question.) Simply put, the Mundell-Fleming approach indicates that a country can have at most two of the following three conditions: a fixed exchange rate, monetary policy autonomy, and capital mobility. Without capital mobility, national authorities can adopt and sustain a monetary policy that differs from the policies of the rest of the world and can hold their exchange rate constant; however, with mobile capital, the attempt will be contravened by financial flows. Assume the authorities want an expansionary monetary policy. Without capital mobility, a fall in interest rates will lead to a rise in demand, and the economy will be stimulated (we ignore longer-term effects on the payments balance). With capital mobility, reduced domestic interest rates will lead to an outflow of capital in search of higher interest rates abroad, and long before monetary policy has a real effect, interest rates will be bid back up to world levels.15 The reason for the result is straightforward: if capital is fully mobile across borders, interest rates are constrained to be the same in all countries and national monetary policy can have no effect on national interest rates. However, to go back to the original conditions, if capital mobility is given (or imposed), monetary policy can be effective if the value of the currency is allowed to vary. Monetary policy operates, in other words, via exchange rates rather than via interest rates as in a typical closed-economy model. With capital mobility, monetary expansion greater than that in the rest of the world causes a financial outflow in which investors sell the currency; the result is currency depreciation. Depreciation in most cases stimulates the economy as prices of foreign goods rise relative to prices of domestically produced goods, thereby increasing local and foreign demand for locally produced goods.16 A parallel story can be told about fiscal policy. If capital is not mobile and the exchange rate is fixed, expansionary fiscal policy raises national interest rates as the government finances increased spending by floating more bonds. The 14. See the following works of Robert A. Mundell: "The Appropriate Use of Monetary and Fiscal Policy Under Fixed Exchange Rates," ZMF StaffPapers 9 (March 1962), pp. 70-77; "Capital Mobility and Stabilization Policy Under Fixed and Flexible Exchange Rates," Canadian Journal of Economics and Political Science 29 (November 1963), pp. 475-85; and "A Reply: Capital Mobility and Size," Canadian Journal of Economics and Political Science 30 (August 1964), pp. 421-31. The basic model can be found in any good textbook discussion of open-economy macroeconomics; a useful survey is W. M. Corden's Inflation, Exchange Rates, and the World Economy, 3d ed. (Chicago: University of Chicago Press, 1986). 15. The argument presented here is in simplified form. Variation in monetary autonomy is actually along a continuum, not dichotomous: the choice is not starkly between full monetary independence and none at all; it is instead among different degrees of autonomy. 16. This ignores the potential contravening effects of the depreciation on national income; that is, it assumes that substitution effects dominate income effects or that expenditure switching dominates expenditure reduction