The this assumption is not valid as the

The Strengths of the Mundell Flemming model are assessed as follows:

The Mundell Fleming model manages to capture a real world figure of the increased economic
integration between economies. Its mechanics provide us with a good base for other advanced
models. The model assumes that prices are fixed and such an assumption has empirical
evidence which in turn provides a useful model to study short to medium term effects of
macroeconomic policy in an open economy.

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However, the model is flexible in the sense that there have been modifications to the model to
allow for flexible prices and wages.

The model assumes easy capital mobility. Such an assumption does have relevance in the
world of today where the financial markets of the world are closely integrated and capital flows
across the world have increased manifold. Add to this that FDI ( foreign direct investment ) flows
are a major source of growth in developing and developed economies. This simply proves that
capital flows are not restricted by national borders.

The inter temporal and monetary models have a higher level of microeconomic base. However,
such models assume a high level of economic integration between economies which leads to
prices being flexible. This is in turn supports no possibility of international goods arbitrage
opportunity. However, there is sufficient evidence against the law of one price. Prices do not
tend to be so flexible which proves that arbitrage operates with a lag and that the Mundell Fleming
model is more suitable for medium to short term analysis.

It offers valuable insight into the behaviour of an economy when there is disturbance or a policy
change. The outcomes predicted by the model can actually be observed in a economy with
regards to short term considerations.

The limitations of the Mundell Flemming model can be assessed as follows

The fact that prices are fixed in the short to medium term has been proved to be correct by
empirical evidence. However, if we use a consumer price index as proxy for the price this
assumption is not valid as the price index tends to fluctuate even in the short-medium term.

The model assumes that we start in an equilibrium state. Such an assumption may be
unreliable. Also, it limits the use of the model from a dynamic perspective and makes it more
suitable for a comparative study

The assumption of easy capital mobility is not always suitable. For example if we were to
assume a country whose government or private sector is likely to default on its debt, such a
country would not attract capital flows at a reasonable rate of return (as the risk premium would be
high). Also, a lot of economies impose capital controls which restricts the flow of capital between
economies. In the current world scenario where we see that protectionism is rising, these controls
might grow.

The model fails to define a sustainable level of domestic consumption. As per the model if
income increases, consumption increases, imports increase which in turn leads to a current
account deficit. Such a deficit is financed by capital inflows. However, eventually such a buildup of
debt may cause the consumption to decrease as the debt may become unsustainable and defaults
may start occurring.

The model does not pay regard to the type of imports and exports. It is very much a possibility that
imports and exports are not impacted to the level as predicted by the model due to consumer
tastes and preferences. To have an impact on exports and imports we need to assume that the
Marshall Lerner conditions hold.

The model makes the assumption that whatever is the demand in the economy is supplied.
The Aggregate supply curve is assumed to be flat. Such an assumption fails to help us
measure the level of internal balance in an economy. We are unable to determine if the
economy is near full employment or away from that point. For example, if we are near full
employment, an expansionary monetary policy might not increase output as much as predicted by
the model as the scope to affect the real economy diminishes near full employment.

The only factor affecting capital flows is not the interest rate differential. A variety of other
factors are important in determining whether capitals flows will take place or not. For example a
country with a high interest rate but with a weak domestic economy with regards to consumption
and investment will not attract a capital.