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**

1)
The simple New Keynesian (NK) model without
capital (background: my handbook chapter).

2) Medium Sized NK model (background paper).

3)
Introducing financial frictions into the New Keynesian DSGE Model.

a)
Microfoundations
for the Costly State Verification (

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.

c)
Very brief discussion of extending CSV to risky banking
(discussion based on papers by Zeng and by Hirakata, Sudo and Ueda).

**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).

a) The
rationale for the principle in the standard NK model (see
section 3.1 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).

**Assignment #9**** **

The
text for this assignment, as well as all the necessary software, is included in
this zip file.