Safe Haven & Mundell Fleming Model

[mich2222]

Suppose you have an economy with a safe haven currency. As the economic outlook in the world gets better, you have an outflow of capital as investors become less risk-averse.

 

In the Mundell Fleming Model, you will experience a weakening of your currency, thought you do not have an intervention from the central bank (thus, the interest rate stays put).

Does it have an effect on the LM-curve or the IS-curve and if so, how?

 

Thank you for the answer.

[fuzzylogician]

This sounds suspiciously like a homework assignment. This forum is dedicated to advice for students applying to graduate school and students attending graduate school. It is not meant for help with homework. I suggest you consult your teacher.

[mich2222]

Your suspicion is wrong.

[fuzzylogician]

Well it sure looks like a copy-pasted question from a textbook. If it's not, then it would be helpful if you gave more background. Where did this question come from? What context should people put it in? What have you tried to do to solve this problem? This community can go to great lengths to help people who try to help themselves, but we will not do other people's work for them.

[mich2222]

Alright, I am trying to analyse today's Switzerland’s monetary situation (I am discussing the situation with a friend and we are not related to any teaching institution (anymore) – I hope my motivation is not too freaky).

 

The CHF is a safe haven currency, which means it strengthens during a global bust and weakens in a global boom (as opposed to currencies of emerging economies for example).

During the latest recession, Switzerland had a very expansionary monetary policy in order to protect the net exports from the positive shock on its currency (the currency appreciated heavily, and the central bank depreciated it a bit by fixing the exchange rate to the EUR).

 

Now that the global outlook might look better, capital is likely to leave the country (the safe haven is less attractive as global risk-aversion decreases). If this situation occurs and the central bank does nothing, I guess it will have two effects on the IS-curve in the Mundell Fleming model.

1^st: Investments are likely to drop as less capital is available (IS-curve to the left?) (Does the deficit in the capital account get larger?)

2^nd: The currency will depreciate which has a positive effect on the net exports (IS-curve to the right?)

It might also change the interest rate parity function in the Mundell Fleming model, as the expected exchange rate is changing, too….

... the more I think, the bigger my confusion…

 

Does anyone knows what occurs in the Mundell Fleming model in the given situation? Thank you!