Reblogging Comments: "Why we should stop teaching Mundell Fleming" (S. Wren-Lewis)
In his last blog post, S. Wren-Lewis from "Mainly Macro" blog argued that the "classical" Mundell-Fleming model should be out of the students macroeconomic course, and the Uncovered Interest Covered (UIP) model instead. The main reason is that Mundel Fleming's assumption that domestic interest rate should be equal to world interest rates, and the theoretical effects that this kind of assumption generates.
Though, S. Wren-Lewis is a little extreme, because one shouldn't eliminate economic theories just because they seem to be wrong (if fact all might be wrong, because of the more o less lack of reality). In other words, we might find UIP model adequate for contemporary analysis, but still have some weakenesses. For instance, arbitrage theory is not totally stable nor efficient, which could be the case of some financial markets. Even so, if efficiency and stability becomes an assumption, the UIP is more discretional, in a simplistic way, which requires lots of modelling by Central Banks in order to properly determine the domestic interest rate and the exchange rate implicit goal.
Moreover, some lessons of history of monetary policy should be taught, and that inevitably must include the "friendly not-so true" Mundell-Fleming model. Perhaps one day it gets assigned to a economic history course if not totally forgotten.