Which model extends IS-LM analysis to an open economy?

The Mundell-Fleming model extends IS-LM analysis to a small open economy.

The framework was developed independently by Robert Mundell and J. Marcus Fleming in the 1960s. It adds international trade, capital flows, the balance of payments, and the exchange rate to the closed-economy IS-LM framework. As a result, domestic output and interest rates are analyzed alongside external financial conditions.

Its most famous implication is the policy trilemma, sometimes called the impossible trinity. A country cannot simultaneously maintain a fixed exchange rate, completely free capital movement, and an independent monetary policy. It can reliably pursue only two of those goals at once.

The model’s policy conclusions depend heavily on the exchange-rate regime. With flexible exchange rates and high capital mobility, fiscal expansion can push up the currency’s value and reduce net exports, limiting its effect on output. Under fixed exchange rates, monetary policy may be constrained because the central bank must intervene in foreign-exchange markets to defend the peg.

A common mistake is to treat Mundell-Fleming as merely a renamed IS-LM diagram. Its defining addition is the open-economy setting, especially exchange-rate behavior and balance-of-payments equilibrium.