DP3980 The BMW Model: Simple Macroeconomics for Closed and Open Economies - A Requiem for the IS/LM-AS/AD and the Mundell-Fleming Model
While the IS/LM-AS/AD model is still the central tool of macroeconomic teaching it has been criticised by several economists. The model is unable to deal with a monetary policy that uses the interest rate as its operating target (Romer [2000]). Walsh [2002] has criticised that it is not suited for an analysis of inflation targeting. We present the BMW model as an alternative framework, which develops the Romer approach into a simple macroeconomic model. It can deal with issues like inflation targeting, monetary policy rules, and central bank credibility. Our open-economy version is 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.
