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The BMW model: simple macroeconomics for closed and open economies a requiem for the IS/LM-AS/AD and the Mundell-Fleming model

  • Bofinger, Peter
  • Mayer, Eric
  • Wollmershäuser, Timo

While the IS/LM-AS/AD model is still the central tool of macroeconomic teaching in most macroeconomic textbooks, it has been criticised by several economists. Colander [1995] has demonstrated that the framework is logically inconsistent, Romer [2000] has shown that it is unable to deal with a monetary policy that uses the interest rate as its operating target, Walsh [2001] has criticised that it is not well suited for an analysis of inflation targeting. In our paper we start with a short discussion of the main flaws of the IS/LM-AS/AD model. We present the BMW model as an alternative framework, which develops the Romer approach into a very simple, but comprehensive macroeconomic model. In spite of its simplicity it can deal with issues like inflation targeting, monetary policy rules, and central bank credibility. We extend the model to an open-economy version as a powerful alternative to the IS/LM-based Mundell-Fleming (MF) model. The main advantage of the open-economy BMW model is its ability to discuss the role of inflation and the determination of flexible exchange rates while the MF model is based on fixed prices and constant exchange rates. This working paper is an extended and more theoretical version of Würzburg Economic Paper No. 34. Besides describing the derivation of optimal interest rate rules and the concept of loss functions more in detail, it also discusses simple interest rate rules in an open economy as well as a strategy of managed floating within the same theoretical framework. Additionally, we explore the stabilizing properties of simple interest rate rules.

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Paper provided by University of Würzburg, Chair for Monetary Policy and International Economics in its series W.E.P. - Würzburg Economic Papers with number 35.

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Date of creation: 2002
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Handle: RePEc:zbw:wuewep:35
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  1. Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, vol. 14(1-2), pages 3-24, February.
  2. Hausmann, Ricardo & Panizza, Ugo & Stein, Ernesto, 2001. "Why do countries float the way they float?," Journal of Development Economics, Elsevier, vol. 66(2), pages 387-414, December.
  3. Guillermo A. Calvo & Carmen M. Reinhart, 2000. "Fear of Floating," NBER Working Papers 7993, National Bureau of Economic Research, Inc.
  4. Flood, R.P. & Rose, A.K., 1992. "Fixing Exchange Rates: A Virtual Quest for Fundamentals," Papers 529, Stockholm - International Economic Studies.
  5. Baxter, Marianne & Stockman, Alan C., 1989. "Business cycles and the exchange-rate regime : Some international evidence," Journal of Monetary Economics, Elsevier, vol. 23(3), pages 377-400, May.
  6. Bofinger, Peter & Mayer, Eric & Wollmershäuser, Timo & Hülsewig, Oliver, 2003. "The BMW model: A new framework for teaching monetary macroeconomics in closed and open economies," W.E.P. - Würzburg Economic Papers 34, University of Würzburg, Chair for Monetary Policy and International Economics.
  7. David Colander, 1995. "The Stories We Tell: A Reconsideration of AS/AD Analysis," Journal of Economic Perspectives, American Economic Association, vol. 9(3), pages 169-188, Summer.
  8. Mccallum, Bennet T., 1988. "Robustness properties of a rule for monetary policy," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 29(1), pages 173-203, January.
  9. David Romer, 2000. "Keynesian Macroeconomics without the LM Curve," NBER Working Papers 7461, National Bureau of Economic Research, Inc.
  10. Stanley Fischer, 2001. "Exchange Rate Regimes: Is the Bipolar View Correct?," Journal of Economic Perspectives, American Economic Association, vol. 15(2), pages 3-24, Spring.
  11. Svensson, Lars E. O., 2002. "Inflation targeting: Should it be modeled as an instrument rule or a targeting rule?," European Economic Review, Elsevier, vol. 46(4-5), pages 771-780, May.
  12. Carmen M. Reinhart, 2000. "Mirage of Floating Exchange Rates," American Economic Review, American Economic Association, vol. 90(2), pages 65-70, May.
  13. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
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