Financial Frictions and the Macroeconomy
By Lawrence J. Christiano
The course will take the form of lectures in each of five mornings. These will concentrate on financial frictions in DSGE models. There will be three and one-half afternoon sessions. These sessions will stress computer exercises involving the solving, simulation and estimation of models.
Lectures and Handouts
1) Introducing financial frictions into the New Keynesian DSGE Model.
a) Microfoundations for the Costly State Verification (CSV) approach.
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.
a) Two approaches based on moral hazard.
i) Two-period financial friction model of Gertler-Kiyotaki, (section 3)
ii) Hidden action (section 4)
b) Adverse selection (section 5).
a) The deflation spiral, the government spending multiplier.
b) Quantitative analysis of the role of the zero bound in the dynamics of US data, 2008 and 2009.
a) News and inflation targeting.
b) Using Ramsey optimal policy as a benchmark for evaluating a policy rule.
5) Introducing unemployment with imperfect labor market insurance into the NK Model (we will most likely not get to this section).
a) Revisiting Lucas’ cost of business cycles.
b) Using unemployment data to estimate the output gap (see section 3.3, 3.4 of handbook chapter).
Apart from giving students hands-on experience with the quantitative analysis of models, the two homework exercises allow us to discuss the following topics:
a) Bayesian estimation of DSGE models.
b) The HP filter as a way to estimate the output gap.
2) The Taylor principle (see section 3.1 of handbook chapter).
a) The rationale for the principle in the standard NK model.
b) Circumstances when things can go awry with the Taylor principle:
i) An important working capital channel.
ii) News shocks.
3) The timeless perspective in Ramsey-optimal monetary policy (handout).
This assignment works heavily with the Clarida-Gali-Gertler model, which is developed here.
The text for this assignment, as well as all the necessary software, is included in this zip file.
The main reference for New Keynesian models is my chapter with Trabandt and Walentin, in the forthcoming Handbook of Monetary Economics, edited by Friedman and Woodford.
The primary reference for financial frictions is Christiano and Daisuke, Government Policy, Credit Markets and Economic Activity.
Other references on financial frictions:
Bernanke, Gertler and Gilchrist’s classic 1999 paper.
Christiano, Motto, Rostagno (2003): Using the BGG model to analyze the cause of the US Great Depression, and the reason it lasted so long.
Christiano, Motto, Rostagno (2009): Using the BGG model to understand the causes of economic fluctuations in the EA and the US.
Government spending and the zero bound:
Christiano, Eichenbaum and Rebelo (2009) When is the Government Spending Multiplier Large?