Three Day Course on the New Keynesian Model
By Lawrence J. Christiano
I plan to review the basic New Keynesian model and some financial friction extensions that are currently under development. The course is aimed at a broad audience, including people actively doing research with dynamic, stochastic, general equilibrium (DSGE) models, as well as people interested in seeing a review of the structure of these models and what they are used for. There will be afternoon homework sessions. The sessions are designed to acquaint participants with Dynare as a tool for analyzing and estimating DSGE models. The first part of these sessions is integrally related to the lectures (especially (1) below), as they explore the fundamental properties and policy implications of the New Keynesian model. In the second part of the afternoon sessions, we will review the fundamentals of Bayesian inference and then do Bayesian inference using Dynare.
Three Morning Lectures
3) Introducing financial frictions into the New Keynesian DSGE Model.
b) Integrating CSV into an NK model and the results of Bayesian estimation of the model using US and EA data.
i) The model.
ii) The importance of risk shocks.
iii) The response of monetary policy to an increase in interest rate spreads.
iv) Background reading: Bernanke, Gertler and Gilchrist’s classic 1999 paper and Christiano-Motto-Rostagno paper to be posted in near future.
Three Afternoon Sessions
Apart from giving participants hands-on experience with the quantitative analysis of models using Dynare, question 2 in assignment 9 allows us to discuss the following topics using the model developed in the first lecture:
1) The sensitivity of the dynamic response of inflation and output to the persistence properties of shocks.
a) Making precise the NK concepts of ‘insufficient aggregate demand’ and ‘excessive aggregate demand’ (see section 3.4 of handbook chapter).
b) The Taylor rule moves the interest rate in the right direction in response to ‘standard’ shocks, but does not move it far enough (see section 3.4 of handbook chapter).
3) Circumstances when things can go awry with the Taylor principle:
a) An important working capital channel may overturn the stabilizing properties of the Taylor principle (section 3.1 of handbook chapter).
b) News shocks may imply that the monetary authority implementing the Taylor principle moves the interest rate in the wrong direction (see Christiano-Ilut-Motto-Rostagno, Jackson Hole paper; and section 3.2 of handbook chapter).
Question 3 in assignment 9 explores Bayesian econometric inference for a DSGE model (see this handout).
The text for this assignment, as well as all the necessary software, is included in this zip file.