By Lawrence J. Christiano
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 the intuition.
We start with a phenomenon that lies at the heart of an emerging consensus about an important factor which amplified the Great Recession in the US: a rollover crisis in the shadow banking system. We do this by reviewing papers by Gertler and Karadi and Gertler and Kiyotaki. We then turn to a model of financial frictions in nonfinancial firms, the model of costly state verification (CSV) and asymmetric information.
After that, we describe the basic New Keynesian model. This model serves as a useful starting point for constructing macroeconomic models. After discussing how to solve the model, we discuss its basic properties. We then introduce CSV financial frictions and argue that the resulting model matches US time series well.
Next, we expand the New Keynesian model to incorporate 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.
2) Financial Frictions in Financial Firms
b) Extending the analysis in (a) to multiperiods and to bank runs (‘rollover crises’), using Gertler-Kiyotaki AER2015 (for an informal discussion of the role of a rollover crisis in the Great Recession, see this and the references therein).
3) Financial Frictions in Nonfinancial Firms
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). Related empirical paper: Levin, Natalucci and Zakrajsek.
b) Introducing the frictions into the neoclassical growth model.
(2) The ‘financial friction wedge': very useful device for thinking about the dynamic effects of financial frictions.
a) The linearized Phillips curve.
b) Solving the model by linearization.
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.) Also shows how the Taylor rule can be too weak in its response to more conventional shocks.
d) Other, related materials.
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.
a) In a two-period version of the model, Ramsey methods show that a leverage restriction on banks raises welfare because it forces them to internalize a particular negative externality associated with issuing deposits.
b) An infinite-horizon version of the model is used to display the implication of the model for dynamics.
a) State space representation of a model.
b) Elements of Bayesian inference (Bayes’ rule, MCMC algorithm).
c) Assignment #9, questions after 1.