How does that fit into the Mundell–Fleming model? Consider Figure 4,
in which again we let France’s pre-1998 equilibrium be disturbed by the downward shift of the IS curve due to falling incomes in and exports to Asia.
Now the FE curve moves down as well, however,
because investors suddenly require a risk premium for holding Asian assets.
As long as French interest rates exceed iW RPW, funds flow out of Asia, making Asian currencies depreciate.
This shifts the IS curve still further to the left, until a new equilibrium obtains in point C at income Ypost-1998.
How does that fit into the Mundell–Fleming model? Consider Figure 4,in which again we let France’s pre-1998 equilibrium be disturbed by the downward shift of the IS curve due to falling incomes in and exports to Asia.Now the FE curve moves down as well, however, because investors suddenly require a risk premium for holding Asian assets. As long as French interest rates exceed iW RPW, funds flow out of Asia, making Asian currencies depreciate.This shifts the IS curve still further to the left, until a new equilibrium obtains in point C at income Ypost-1998.
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