1. „BMW-Model“: A new framework for teaching macroeconomics : Monetary and Fiscal Policy Interaction in a closed Economy Peter Bofinger, Eric Mayer Universität Würzburg

2. Introduction BMW Model The BMW-Model: New Keynesian Macroeconomics for Undergraduates è Part 1 : "The BMW model: a new framework for teaching monetary macroeconomics in closed and open economies", Würzburg Economic Paper No. 34, July 2002. è Part 2a : " The BMW model: A new framework for teaching macroeconomics: Monetary and fiscal policy interaction in a closed economy", mimeo, October 2003. è Part 2b : "Monetary and fiscal policy interaction in the euro area with different assumptions on the Phillips curve", Würzburg Economic Papers No. 40, October 2003. è Part 3: "The BMW model as a static approximation of a foreward-looking New Keynesian macromodel", "Würzburg Economic Papers No. 42, November

3. The BMW-Model Closed economy Application I Application II Application III Nominal Interest Rate Trap Investment Trap Ordinary Times Stabilization Bias (Ambitious Government)

4. Building Blocks “Static New Keynesian Macro Model “ Static Phillips curve Static IS-Equation Policy rules Monetary policy Fiscal policy

5. Chart 1: What does fiscal policy do? r y r0r0 0 y1y1 y2y2 r(  1,  2 )

6. Strategic Interaction: Monetary Policy Monetary Policy Which results in the following instrument rule („reaction function“) s.t.

7. Chart 3b: The Instrument Rule („Reaction function“): What is the optimal interest rate r* if the government chooses g r g r*(g) 0 g1g1 r1r1

8. Strategic Interaction: Fiscal Policy Fiscal policy: Which results into the following instrument rule („reaction function“) s.t.

9. r g Chart 4b: The Instrument Rule („Reaction function“): What is the optimal fiscal stance g* if monetary policy r

10. Application I A Nominal Interest Rate Trap Investment Trap

11. Chart 5: Assume that the economy is hit by a large demand shock: Nominal interest rate trap r y r1r1 r0r0 r1(g0,1)r1(g0,1) r 1 (g*,  1 ) AB

12. r y r0r0 0 y1y1 r(  1,  2 ) r1r1 Chart 6: Assume that investors are admost pessimistic: Investment Trap

13. Application II Ordinary Times

14. r*(g) r g r g g*(r) Nash-Equilibrium (r*,g*) 0 Chart 8b: Nash Equilibrium: Outcome of the game r y r 0 =(a/b) 0

15. Application III Stabilization bias: Debt Bias Fiscal Policy is overly ambitious and tries to push output above potential

16. r g Chart 10a: The New Reaction Function: For every real interest rate r, fiscal policy is more expansive

17. r y r0r0 0 y1y1 r(  1,  2 ) Chart 10b: Which looks in the (y,r)-space as follows

18. r y r0r0 0 r1r1 B C y>0 A Chart 11a: But as monetary policy can push ist preferred outcome through r g r*(g) Nash-Equilibrium (r*,g*)