the IS curve (such as government spending changes) will be exactly offset by resulting exchange rate changes, and the IS curve will end up in its original position, still intersecting the LM and BoP curves at their intersection point. The Mundell–Fleming model under a fixed exchange rate regime also has completely different implications from those of the closed economy IS-LM model. In the closed economy model, if the central bank expands the money supply the LM curve shifts out, and as a result income goes up and the domestic interest rate goes down. But in the Mundell–Fleming open economy model with perfect capital mobility, monetary policy becomes ineffective. An expansionary monetary policy resulting in an incipient outward shift of the LM curve would make capital flow out of the economy. The central bank under a fixed exchange rate system would have to instantaneously intervene by selling foreign money in exchange for domestic money to maintain the exchange rate. The accommodated monetary outflows exactly offset the intended rise in the domestic money supply, completely offsetting the tendency of the LM curve to shift to the right, and the interest rate remains equal to the world rate of interest. Criticism Exchange rate expectations One of the assumptions of the Mundell–Fleming model is that domestic and foreign securities are perfect substitutes. Provided the world interest rate is given, the model predicts the domestic rate will become the same level of the world rate by arbitrage in money markets. However, in reality, the world interest rate is different from the domestic rate. Rüdiger Dornbusch considered how exchange rate expectations have an effect on the exchange rate. Given the approximate formula: and if the elasticity of expectations , is less than unity, then we have Since domestic output is , the differentiation of income with regard to the exchange rate becomes The standard IS-LM theory gives us the following basic relations: Investment and consumption increase as the interest rates decrease, and currency depreciation improves the trade balance. Then the total differentiations of trade balance and the demand for money are derived. and then, it turns out that The denominator is positive, and the numerator is positive or negative. Thus, a monetary expansion, in the short run, does not necessarily improve the trade balance. This result is not compatible with what the Mundell-Fleming predicts. This is a consequence of introducing exchange rate expectations which the MF