The Nobel Prize

Robert A. Mundell (b. 1932)

Robert Mundell was born in Kingston, Ontario, Canada in 1932. He obtained a BA from the University of British Columbia in 1953 and an MA from the University of Washington in 1954. After studying at the London School of Economics and the Massachusetts Institute of Technology (MIT) he received his PhD from MIT in 1956. His doctoral thesis concerned aspects of international capital movements, a topic that was to become a focus of much of his subsequent research. Mundell held a Post-Doctoral Fellowship in Political Economy at the University of Chicago (1956–57), taught at Stanford University (Assistant Professor of Economics, 1958–59) and the Johns Hopkins University School of Advanced International Studies in Bologna, Italy (Professor of Economics, 1959–61), before joining the research department of the International Monetary Fund (IMF) as a senior economist (1961–63). The IMF’s research department at that time was headed by Marcus Fleming. Subsequent posts included: Visiting Professor of Economics at McGill University (1963–64); Visiting Research Professor of International Economics at the Brookings Institution (1964–65); (summer) Professor of International Economics at the Graduate Institute of International Studies in Geneva, Switzerland (1965–75); Professor of Economics at the University of Chicago (1966–71), where he was editor of the Journal of Political Economy (1966–70); and Professor of Economics at the University of Waterloo, Ontario (1972–74). Since 1974, Mundell has been Professor of Economics at Columbia University in New York.

Mundell’s many offices and honours have included the award of the title of distinguished fellow of the American Economic Association in 1997 and a fellowship of the American Academy of Arts and Sciences in 1998. In 1999 Mundell was awarded the Nobel Memorial Prize in Economics ‘for his analysis of monetary and fiscal policy under different exchange rate regimes and his analysis of optimum currency areas’ (Nobel Foundation, 2004).

Mundell’s pioneering contributions to open economy or international economics can be divided into three main areas: the development of the so-called Mundell–Fleming model and its implications for the effectiveness of fiscal and monetary policy under different exchange rate regimes; his work emphasising the importance of monetary dynamics; and the development of the concept of an optimum currency area. While these path-breaking contributions (see, for example, the collection of essays gathered together in Mundell, 1968; 1971a) date from the 1960s, their lasting significance is reflected in the key part they still play at the heart of open economy macroeconomic courses. Furthermore, his contributions have provided fertile ground since the 1960s for researchers to extend and refine his original analyses.

The Mundell–Fleming model derives its name from the work of Robert Mundell and Marcus Fleming. Writing independently while at the IMF, both researchers incorporated international trade and capital movements into the IS–LM model of a closed economy (a model initially developed by John Hicks the 1972 Nobel Memorial Laureate). Mundell (1963b) demonstrated that for a small open economy, with perfect capital mobility, the effects of monetary and fiscal policy critically depend on whether the exchange rate is fixed or flexible. Under a fixed exchange rate the money supply is endogenous and monetary policy becomes totally ineffective in changing the level of domestic economic activity. Any attempt to increase the money supply by open market purchases of securities will merely lead to an offsetting loss of foreign exchange reserves. In contrast, fiscal policy becomes effective as there is no crowding out since the domestic interest rate is tied to the rate ruling abroad. Under a flexible exchange rate the money supply is exogenous and monetary policy becomes effective in changing the level of domestic economic activity. An increase in the money supply implies lower interest rates which results in capital outflows and a depreciation of the exchange rate. This in turn causes an increase in aggregate demand (through an increase in net exports) and higher output. In contrast, fiscal policy becomes totally ineffective. An increase in government expenditure puts upward pressure on the domestic interest rate, resulting in an inflow of capital and an appreciation of the exchange rate. As the exchange rate appreciates net exports decrease, completely offsetting the effects of increased government expenditure. In this way fiscal expansion crowds out net exports and there is no change in output.

A second key contribution made by Mundell to open economy macroeconomics relates to his work on the importance of monetary dynamics. This can be seen in three main uses. First, he analysed how persistent international payments imbalances could arise and how they would eventually be eliminated. In his approach, the private sector’s money holdings (and thereby its stock of wealth) change in response to balance of payments surpluses or deficits (flows). For example, under fixed exchange rates with a low degree of capital mobility, an increase in the money supply will reduce interest rates, increase domestic demand and cause a balance of payments deficit. The deficit will result in monetary outflows and a fall in demand until the balance of payments deficit is eliminated. Mundell’s approach was subsequently adopted by others and was developed into the monetary approach to the balance of payments. One important conclusion that derives from his analysis is that attempts by the authorities to sterilise balance of payments deficits/ surpluses will disrupt the adjustment mechanism. Second, Mundell (1962) used dynamic principles to solve the so-called ‘assignment problem’. Employing a Keynesian model operating under a fixed exchange rate with imperfect capital mobility, he considered the appropriate use of monetary and fiscal policy for internal and external stability. He demonstrated how monetary policy should be assigned to achieve external balance and fiscal policy to achieve internal balance. With the reverse assignment the economy would be dynamically unstable, experiencing progressively rising unemployment and a deteriorating balance of payments situation. The explanation for this is related to his ‘principle of effective market classification’ (Mundell, 1960), in that policy instruments should be assigned to the objectives on which they have the most direct influence. Third, Mundell’s work on monetary dynamics results in his ‘incompatibility trinity’ whereby, given capital mobility, monetary policy can be directed towards either an external objective (for example, the exchange rate) or an internal objective (for example, inflation) but not both at the same time.

The third area in which he has made a major contribution to open economy macroeconomics is in the development of the concept of an optimum currency area. At the time of the Bretton Woods regime of fixed exchange rates, Mundell (1961) posed the then radical and far-sighted question ‘when is it advantageous for a number of regions to relinquish their monetary sovereignty in favour of a common currency?’. Addressing this question he considered both the advantages (for example, lower transaction costs) and disadvantages (for example, the problem of maintaining employment when ‘asymmetric shocks’ necessitate a reduction in real wages in a particular region) of a common currency. He found an optimum currency area to be a set of regions within which the degree of labour mobility is high enough to ensure full employment when one particular region experiences a disturbance. Surprisingly, given Europe’s inflexible labour market, Mundell has been a strong supporter of European Monetary Union (see, for example, Mundell, 1973; 1997) and many regard him (inaccurately) as the father of the euro.

In addition to the three main contributions noted above, Mundell has also made a number of other important contributions to macroeconomic theory and the theory of trade. These include: in the former case the ‘Mundell–Tobin effect’ where a higher rate of inflation may induce people to reduce their real cash balances and invest more in real capital assets (see Mundell, 1963a); and in the latter case the argument that factor mobility tends to equalise goods prices, even if international trade is restricted by trade barriers (Mundell, 1957). In the 1970s, in the field of economic policy, his enthusiasm for tax cuts (see Mundell, 1971b) helped found supplyside economics. Over recent years he has been working on the history of the international monetary system (see Mundell, 2000).

Main Published Works
(1957), ‘International Trade and Factor Mobility’, American Economic Review, 47, June, pp. 321– 35; reprinted in R.E. Caves and H.G. Johnson (eds)
(1968), Readings in International Economics, Homewood, IL: R.D. Irwin.
(1960), ‘The Monetary Dynamics of International Adjustment under Fixed and Flexible Exchange Rates’, Quarterly Journal of Economics, 84, May, pp. 227–57.
(1961), ‘A Theory of Optimum Currency Areas’, American Economic Review, 51, September, pp. 657–65; reprinted in M. Ugur (ed.)
(2002), An Open Economy Macroeconomics Reader, London: Routledge, pp. 345–53. (1962), ‘The Appropriate Use of Monetary and Fiscal Policy for Internal and External Stability’, IMF Staff Papers, March, pp. 70–79; reprinted in M. Ugur (ed.)
(2002), An Open Economy Macroeconomics Reader, London: Routledge, pp. 132–8. (1963a), ‘Inflation and Real Interest’, Journal of Political Economy, 71, June, pp. 280–83. (1963b), ‘Capital Mobility and Stabilisation Policy under Fixed and Flexible Exchange Rates’, Canadian Journal of Economics and Political Science, 29, November, pp. 475–85; reprinted in M. Ugur (ed.)
(2002), An Open Economy Macroeconomics Reader, London: Routledge, pp. 7– 18.
(1968), International Economics, New York: Macmillan.
(1971a), Monetary Theory: Interest, Inflation and Growth in the World Economy, Pacific Palisades, CA: Goodyear.
(1971b), ‘The Dollar and the Policy Mix’, Essays in International Finance, no. 85, Princeton, NJ: Princeton University Press.
(1973), ‘A Plan for a Common Currency’, in H. Johnson and A. Swoboda (eds)
(1973), The Economics of Common Currencies, London: George Allen & Unwin.

(1997), ‘Currency Areas, Common Currencies and EMU’, American Economic Review, 87, May, pp. 214–16.
(2000), ‘The International Monetary System at the Beginning of the New Millennium’, Journal of Economic Research, 5, May, pp. 1–15.

Secondary Literature
Dornbusch, R. (2000), ‘Robert A. Mundell’s Nobel Memorial Prize’, Scandinavian Journal of Economics, 102, June, pp. 199–210 and pp. 223–34.
Rose, A.K. (2000), ‘A Review of Some of the Economic Contributions of Robert A. Mundell, Winner of the 1999 Nobel Memorial Prize in Economics’, Scandinavian Journal of Economics, 102, June, pp. 211–22 and pp. 223–34.
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