ECS3703
Assignment 1 Semester 1 2026
Unique number:
Due Date: 2 April 2026
This document includes:
Helpful answers and guidelines
Detailed explanations and/ or calculations
References
Connect with the tutor on
+27 81 278 3372
, QUESTION 1
(a)
Under a flexible exchange rate system, SADC countries that want to maintain both
full employment and a balanced current account must choose their macroeconomic
policy according to the degree of capital mobility. The Mundell Fleming framework
shows that the effectiveness of fiscal and monetary policy changes depending on
whether capital is highly mobile or not.
Perfect capital mobility
When there is perfect capital mobility, monetary policy is the most effective tool
under flexible exchange rates. If a country expands its money supply, domestic
interest rates fall below world interest rates. This causes capital outflows because
investors move funds to countries with higher returns. The local currency then
depreciates. A weaker currency makes exports cheaper and imports more
expensive, which improves net exports and raises aggregate demand, output, and
employment. In this case, monetary policy helps the country move toward full
employment, while the exchange rate adjustment helps correct external imbalance
and support a balanced current account (Salvatore, 2019).
Fiscal policy is less effective under perfect capital mobility. If government increases
spending or cuts taxes, income rises and interest rates tend to increase. This attracts
large capital inflows, causing the domestic currency to appreciate. Currency
appreciation reduces exports and increases imports, which offsets the expansionary
effect of fiscal policy. As a result, fiscal policy becomes weak under flexible
exchange rates with perfect capital mobility (Salvatore, 2019).
Imperfect capital mobility
When capital mobility is imperfect, both monetary and fiscal policy can have an
effect, but monetary policy still plays an important role under flexible exchange rates.
An expansionary monetary policy lowers interest rates, causes some capital outflow,
and leads to currency depreciation. Because capital is not perfectly mobile, the
capital outflow is smaller than under perfect mobility, but the depreciation still
improves net exports and increases output and employment. This makes monetary
© Study Shack 2026. All rights Reserved +27 81 278 3372
Assignment 1 Semester 1 2026
Unique number:
Due Date: 2 April 2026
This document includes:
Helpful answers and guidelines
Detailed explanations and/ or calculations
References
Connect with the tutor on
+27 81 278 3372
, QUESTION 1
(a)
Under a flexible exchange rate system, SADC countries that want to maintain both
full employment and a balanced current account must choose their macroeconomic
policy according to the degree of capital mobility. The Mundell Fleming framework
shows that the effectiveness of fiscal and monetary policy changes depending on
whether capital is highly mobile or not.
Perfect capital mobility
When there is perfect capital mobility, monetary policy is the most effective tool
under flexible exchange rates. If a country expands its money supply, domestic
interest rates fall below world interest rates. This causes capital outflows because
investors move funds to countries with higher returns. The local currency then
depreciates. A weaker currency makes exports cheaper and imports more
expensive, which improves net exports and raises aggregate demand, output, and
employment. In this case, monetary policy helps the country move toward full
employment, while the exchange rate adjustment helps correct external imbalance
and support a balanced current account (Salvatore, 2019).
Fiscal policy is less effective under perfect capital mobility. If government increases
spending or cuts taxes, income rises and interest rates tend to increase. This attracts
large capital inflows, causing the domestic currency to appreciate. Currency
appreciation reduces exports and increases imports, which offsets the expansionary
effect of fiscal policy. As a result, fiscal policy becomes weak under flexible
exchange rates with perfect capital mobility (Salvatore, 2019).
Imperfect capital mobility
When capital mobility is imperfect, both monetary and fiscal policy can have an
effect, but monetary policy still plays an important role under flexible exchange rates.
An expansionary monetary policy lowers interest rates, causes some capital outflow,
and leads to currency depreciation. Because capital is not perfectly mobile, the
capital outflow is smaller than under perfect mobility, but the depreciation still
improves net exports and increases output and employment. This makes monetary
© Study Shack 2026. All rights Reserved +27 81 278 3372
