By Lawrence J. Christiano
Overview
This is a
graduate course on the basic tools for the rapidly growing field of
Macro/Finance. It is geared to students
who will go on to do this type of work in their own research. For this reason,
the course will not shy away from the technical details. At the same time there
will be a constant focus on getting the intuition right.
Most of the
models of finance that we will review in effect represent disturbances to the ‘intertemporal margin’.
In models with frictionless labor and goods markets financial frictions
on the intertemporal margin tend to drive consumption
and investment in opposite directions. But, macro data indicate that
consumption and investment move in the same direction. For this and other
reasons, we will use the New Keynesian model as our basic macroeconomic
platform. For reasons we will see, this model has the advantage of predicting
that consumption and labor move in the same direction. In recent years this
model has also performed well on several other empirical dimensions: it
predicted correctly that fiscal austerity slows down economic activity, rather
than speed it up; it predicted correctly that the high money growth in recent
years would be associated with low, rather than high inflation.
Next, we
turn to models of financial frictions. I will organize the discussion around
frictions on the liability and asset sides of financial firm balance sheets. Our
analysis will help us in thinking about various problems in monetary policy:
how monetary policy should respond to changes in interest rate spreads, what
the effect of various types of unconventional monetary policy are, as well as
macro prudential policy. We
will review Bayesian econometric methods because they are the key tool for the
estimation and empirical evaluation of the models we will review. Students will
get hands-on practice in the use of Dynare to solve,
estimate and analyze dynamic models.
Lectures
1) The New Keynesian (NK) model (handout,
manuscript):
basic principles and policy implications (Dynare code
for solving and simulating the model in the handout, with some notes
on how Dynare does it).
a) The version described is inspired by
recent improvements in understanding the network nature of actual production (Acemoglu, et al, 2015; see
also). For example, networks can help provide an endogenous theory of price
sluggishness through a strategic complementarity mechanism. They also convert
the New Keynesian model into a quantitatively serious theory about the costs of
inflation.
b) Assignment #9,
question 1, accomplishes two 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.
c) Other,
related materials.
2) Financial
frictions on the asset side of banks’ balance sheets.
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).
i) A microeconomic approach.
Related empirical paper: Levin,
Natalucci and Zakrajsek.
ii) Introducing the frictions into a
neoclassical growth model.
(1)
Aggregation.
(2)
The
‘financial friction wedge': very useful device for thinking about the dynamic effects
of financial frictions.
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.
3) Financial frictions on the liability
side of banks’ balance sheets.
a) 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).
b) Extending
the analysis in (a) to multiperiods and to bank runs
(‘rollover crises’), using Gertler-Kiyotaki AER2015.
c) Dynamic Model in which financial frictions stem
from the fact that to do their job well, bankers must exert costly but
unobserved effort. The environment has the implication that imposing
leverage restrictions on banks can raise social welfare by addressing an
externality. It thus provides a laboratory for thinking about macro prudential
policy (background manuscript).
d) The reading also shows (in two-period
settings) how financial frictions on the liability side of banks’ balance sheet
can arise from adverse selection and costly state verification. We will not
discuss these cases in the lectures.
4) Estimation of DSGE
models (the handout makes some references to these 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) Assignment #9, questions after 1.
5) A small open economy New
Keynesian model.
a) Extending the simple model to the open economy, following the approach
of Adolfson-Laséen-Lindé-Villan
(RAMSES I).
i) Computer code for
exploring the properties of the model.
ii) Further extensions to bring the model to the data.
b) Incorporating financial frictions into the model, following the
approach of Christiano-Trabandt-Walentin
(RAMSES II).
i) A discussion of the work of Mihai Copaciu addressing
the interaction of possible currency mismatch problems in emerging markets and
the US Federal Reserve’s eventual ‘exit strategy’.
ii) A slightly simplified version of
the CTW model is described here (the relatively complicated
labor market part of CTW is replaced by a standard sticky wage setup). You can
see how the model is estimated on Swedish data. There are instructions for
replacing the Swedish data with another country’s data and using the code to
analyze that.
Background readings
The main reference for New Keynesian
models is my chapter with Trabandt and Walentin, in the Handbook of Monetary Economics, edited by
Friedman and Woodford.
The primary reference for financial frictions on the liability side of
banks’ balance sheets is Christiano and Daisuke, Government Policy, Credit
Markets and Economic Activity.
An extensive applications of
the methods described in the course, to understand recent events in the US:
Christiano, Eichenbaum
and Trabandt (AEJ-M 2015), ‘Understanding
the Great Recession’.