New Keynesian DSGE Models, Financial Frictions and Bayesian
Estimation
By Lawrence J. Christiano
Overview
This is a
graduate-level course on tools for macroeconomics. It is geared to people
interested in applying the tools in situations not necessarily considered
previously in the literature. For this reason, the course will not shy away
from the technical details. At the same time, there will be a constant focus on
the intuition.
We begin by
describing the basic New Keynesian closed economy model with no capital. The
simplicity of this model will allow us to highlight core principles that apply
more generally across models with price-setting frictions. It will also allow
us to focus on a core technical problem in the New Keynesian model, how to
aggregate across heterogeneous firms.
We then turn
to a discussion of the econometric tools for estimating dynamic, stochastic,
general equilibrium models like the New Keynesian model.
Next we
extend the NK model into an open economy setting. We discuss properties of the
model, its limitations, as well as problems (e.g., the UIP puzzle) which have
been the focus of open economy macro for a long time and which still resist a
satisfactory solution.
Finally, we
consider financial frictions. We will examine in detail the consequences of
incorporating financial frictions on the asset side of banks’ balance sheets.
We will also discuss, at a more informal level, financial frictions on the
liability side of banks’ balance sheets.
Computer
exercises will give students hands-on practice in the use of Dynare to solve,
estimate and analyze dynamic models.
Lectures
1) The simple New Keynesian (NK) lecture
1 and lecture
2 on model without capital (background: my handbook chapter, and this
comment on Acemoglu, et al, Macro
Annual, 2015). We will stress the key role in short term economic dynamics of
aggregate demand, and the importance of good policy for guiding it. We will
evaluate inflation targeting from this point of view
a) Handout
on linearization as a tool for solving models (a more in depth discussion
appears here).
b) Derivation of linearized NK Phillips
curve.
c) Assignment #9,
question 1, accomplishes three things.
i) Gives students experience with Dynare
for solving and simulating models.
ii) Gets to the heart of the New
Keynesian models by exploring its basic underlying economic principles.
iii)
Shows
how ‘news’ shocks might cause an inflation targeter
to drive the interest rate in the ‘wrong’ direction and inadvertently trigger
an inefficient stock market boom (Slides,
manuscript;
and section 3.2 of handbook
chapter.)
d) Other,
related materials.
2) Estimation of DSGE
models (the handout makes some references to this note on model
solution and here is a note on the
appropriate acceptance rate for the MCMC algorithm).
a) State space representation of a model.
b) Elements of Bayesian inference (Bayes’ rule, MCMC algorithm).
c) A simple example
to illustrate Bayes’ rule.
d) Assignment #9, questions after 1.
3) Extending
the NK model to the open economy. This is a drastically simplified version of
the model in here.
Code
to generate graphs in the lecture notes.
4) Financial.
a) Micro foundations for the Costly State Verification (CSV) approach (zip file with code for the computations, and a version of the slides with more extensive derivations). The CSV model
is used as a friction on the asset side of a bank’s balance sheet.
b) Integrating CSV into a New Keynesian model and
the results of Bayesian estimation of the model using US data (CMR,
JMCB
2003, AER 2014).
i) The model.
ii) The importance of risk shocks and
news on risk.
iii)
The
response of monetary policy to an increase in interest rate spreads.
iv)
Carefully
documented (thanks to Ben Johannsen) Dynare code for replicating the material in
this presentation.
c)
Financial
frictions on the liability side of banks’ balance sheet. Two-period exposition of Gertler-Karadi/Gertler-Kiyotaki model in which the financial frictions
stem from bankers’ ability to ‘run away’ (section 3 of reading, handout).