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234 CHAPTER 8. THE MUNDELL-FLEMING MODELrLMr*(2)y 1(1)FFISyy 0Figure 8.3: An increase in i ∗ generates a capital outßow, a loss of centralbank reserves, and a contraction of the domestic money supply.monetary shocks are positively transmitted internationally as they leadto positive output comovements at home and abroad. If the increase ini ∗ was the result of expansionary foreign government spending, foreignoutput expands whereas domestic output contracts. Aggregate expenditureshocks are said to be negatively transmitted internationally undera Þxed exchange rate regime.A currency devaluation has negative transmission effects. The devaluationof the home currency is equivalent to a revaluation of theforeign currency. Since the domestic currency devaluation has an expansionaryeffect on the home country, it must have a contractionaryeffect on the foreign country. A devaluation that expands the homecountry at the expense of the foreign country is referred to as a beggarthy-neighborpolicy.Flexible Exchange RatesWhen the authorities do not intervene in the foreign exchange market,s and y are endogenous in the system (8.4)-(8.5) and the authoritiesregain control over m, which is treated as exogenous.Domestic credit expansion. An expansionary monetary policy generatesan incipient capital outßow which leads to a depreciation of the