Eric Mayer

The BMW Model: A New Framework for Teaching Monetary Economics

Abstract: Although the IS/LM-AS/AD model is still the central tool of macroeconomic teaching in most macroeconomic textbooks, it has been criticized by several economists. Colander (1995) demonstrated that the framework is logically inconsistent, Romer (2000) showed that it is unable to deal with a monetary policy that uses the interest rate as its operating target, and Walsh criticized that it is not well suited for an analysis of inflation targeting. The authors present a framework that develops the Romer approach into a very simple but, at the same time, comprehensive macroeconomic model. In spite of its simplicity, it can carry the main insights of the New Keynesian macroeconomics to an intermediate level and deal with issues like inflation targeting, monetary policy rules, and central bank credibility.

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 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 Wurzburg 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.

The BMW Model: A New Framework for Teaching Monetary Macroeconomics in Closed and Open Economies

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.

The Svensson versus McCallum and Nelson Controversy Revisited in the BMW Framework

This note shows that the Svensson versus McCallum and Nelson controversy battled in the Federal Reserve Bank of St. Loius Review (September/ October 2005) can be mapped into a static version of a New Keynesian macro model that consists of an IS-equation, a Phillips curve and an inflation targeting central bank (e.g., Bofinger, Mayer, Wollmershauser, (2006); Walsh (2002)). As a contribution to literature we supplement the controversy by a forceful graphical analysis. The general debate centers on the question by which notion monetary policy should be implemented. The two sides have fundamentally opposite views on this issue. Svensson argues for targeting rules as a notion of optimal monetary policy, whereas McCallum and Nelson promote simple instrument rules. In this note we systematically analyze these two categories of monetary policy rules. In particular we show that the rule discussed by McCallum and Nelson (2005) imposes different degrees of variability on the economy compared to a targeting rule when monetary policy falls prey to measurement error. To our opinion the hybrid Taylor rule developed by McCallum and Nelson contradicts the original idea of simple rules as a heuristic for monetary policy making and should be rebutted for practical reasons

The Mechanics of a Reasonably Fitted Quarterly New Keynesian Macro Model

The last years have witnessed a sharp increase of interest in monetary policy rules (see Taylor [1999]). This normative branch of monetary policy tries to evaluate the performance of alternative monetary policy rules in terms of associated monetary policy outcomes. Nevertheless this exercise is crucially based on the assumption that key parameters of the model are realistically specified. This holds in particular true for the preference vector of the central bank which trades off the individual goal variables of monetary policy and the degree of forward lookingness in the Phillips curve and the IS equation. Based on matching moments and the implied autocorrelations and cross correlations we present evidence for the USA covering the term of Allan Greenspan (1987:4- 2002:2) that hybrid specifications of the Phillips curve and the IS-curve are characterized by approximately 60% of backward looking economic agents. The predominant goal of monetary policy is price stability and financial market stability. Output gap stabilizationonly seems to play a minor role as an independent goal for the conduct of monetary policy.

Monetary and Fiscal Policy Interaction in the Euro Area with Different Assumptions on the Phillips Curve

In this Paper we carry over a static version of a New Keynesian Macromodel a la Clarida Gali Gertler (1999) to a monetary union. We will show in particular that a harmonious functioning of a monetary union critically depends on the correlation of shocks that hit the currency area. Additionally a high degree of integration in product markets is advantageous for the ECB as it prevents that national real interest rates can drive a wedge between macroeconomic outcomes across member states. In particular small countries are vulnerable and therefore in need of fiscal policy as an independent stabilization agent with room to breath.

The BMW model as a static approximation of a foreward-looking New Keynesian macroeconomic model

Over the last decade a new consensus model has emerged in monetary macroeconomics, labelled New Keynesian macroeconomics (Clarida et al., 1999). It consists of three simple building blocs: a forward-looking IS-equation that is derived from the optimization problem of a representative household, a forward-looking Phillips curve that maps the optimal pricing decisions of monopolistically competitive firms facing restrictions on their ability to adjust wages or prices in a flexible manner, and a relationship that describes how monetary policy is conducted. In Bofinger, Mayer and Wollmershauser (2002a, 2002b) we developed the BMW model which takes this standard dynamic macro model to an intermediate audience in a down-to-earth fashion. This paper presents the linkages between our static BMW approach and a dynamic New Keynesian macro model.

Heterogeneous Mortgage Markets: Implications for Business Cycles and Welfare in the EMU

Abstract This paper evaluates business cycle effects of asymmetric cross-country mortgage market developments in a monetary union. By employing a two-country New Keynesian DSGE model with collateral constraints tied to housing values, we show that a change in institutional characteristics of mortgage markets, such as the loan-to-value (LTV) ratio, is an important driver of asymmetric developments in housing markets and economic activity. Our analysis suggests that the home country where credit standards are lax booms, while the rest of European Monetary Union faces a negative output gap. Overall welfare is lower if LTV ratios are higher.

The Svensson versus McCallum and Nelson Controversy Revisited in the BMW Framework: A Clarification

Zusammenfassung Svensson auf der einen und McCallum und Nelson auf der anderen Seite haben in einer Reihe von Beiträgen kontrovers diskutiert, an welcher geldpolitischer Regel sich eine Notenbank orientieren sollte (vgl. Svensson, L., 2003a, 2003b, 2005, Svensson L., u. Woodford, M. 2005). Hierbei plädiert Svensson für so genannte Targeting Regeln. Allgemein kann man diese definieren als Reaktionsfunktion der Notenbank, die eine Regel in den Zielvariablen der Geldpolitik (Inflationslücke und Outputlücke) definiert und unmittelbar aus dem Optimierungsproblem ableitbar ist; sie stellt sozusagen eine Bedingung erster Ordnung dar. McCallum und Nelson hingegen befürworten die Orientierung an einfachen Regeln, die sich an wenigen, beobachtbaren makroökonomischen Zielgrößen orientieren und nicht fein abgestimmt sind auf eine konkrete Zielfunktion oder aber ein Modell. McCallum und Nelson haben im Rahmen dieser Debatte hybride eine Regel vorgeschlagen, die als Spezialfall sowohl eine einfache Regel wie die Taylor Regel (Taylor, J. 1993) als auch die optimale Regel beinhaltet. Im Rahmen unseres Beitrages haben wir analytisch und grafisch nachgewiesen, dass im Grenzfall die Regel von McCallum und Nelson und die optimale Targeting Regel von Svensson identische Politikergebnisse liefern und somit je nach Kalibrierung kein Unterschied zwischen beiden Regeln besteht. Svensson argumentiert im Rahmen der Debatte, dass insbesondere die Existenz von verrauscht gemessenen Daten die Regel von McCallum und Nelson obsolet werden lässt, da sie die Ökonomie einer enormen Zinsvolatilität aussetzen würde. Wir haben jedoch analytisch und grafisch dargestellt, dass gerade unter Datenunsicherheit die Regel von McCallum und Nelson unabhängig von der konkreten Kalibrierung bessere Politikergebnisse liefert als die Targeting Regel von Svensson. Als Ursache dafür, dass es uns gelungen ist, das Argument von Svensson zu widerlegen, ist anzuführen, dass die einfache Regel weniger aggressiv auf Datenänderungen reagiert als die optimale Regel. Reagiert die Notenbank nun aber fälschlicherweise auf verrauscht gemessene Daten, so entpuppt sich dieser Nachteil in normalen Zeiten als Vorteil in einem solchen Szenario. Die Zinsvolatilität einer Targeting Regel ist also höher als die unter einer einfachen Regel.

Das BMW-Modell: Neukeynesianische monetäre Makroökonomie für die Lehre

Trotz zunehmender Kritik wird in den meisten Lehrbuchern das IS/LM-AS/AD-Modell noch immer als das Standardmodell der Makrookonomie darstellt. In einer Reihe von Beitragen haben Bofinger, Mayer und Wollmershauser (2002a, 2002b, 2003a und 2003b) einen alternativen Modelrahmen, das sog. BMW-Modell, prasentiert, der den Ansatz von Romer (2000) in ein einfaches, aber uberzeugendes makrookonomisches Model uberfuhrt. Trotz seiner Einfachheit eignet sich das BMW-Modell zur Diskussion relevanter Fragestellungen wie etwa dem Konzept des Inflation Targeting, geldpolitischer Regelbindung oder der Glaubwurdigkeit von Geldpolitik. Dieser Beitrag fasst die wichtigsten Elemente des BMW-Modells zusammen.