The New Keynesian Model: Computational and Econometric Tools, and
Financial and Labor Market Extensions

By Lawrence J.
Christiano

**Overview**

The course begins with a review of computational and econometric
tools useful in the analysis of dynamic, stochastic general equilibrium (DSGE)
models. After a very brief review of the basic New Keynesian model, we discuss
extensions of the model to introduce financial and labor market frictions.
Finally, we use a model of financial frictions to discuss the interaction
between monetary policy and stock market volatility. Afternoon sessions will be
devoted to computer exercises using Dynare that illustrate the points discussed
in the lectures.

**Lectures**

1.
Introductory
remarks.

2.
Overview
of tools for solving DSGE models: Perturbation and Projection methods with a
Dynare file
to do the computations reported in the handout.

· a
more __detailed__ version of this handout, with software used to generate the graphs in the
more detailed handout, and a zip file that uses Dynare to do some of the computations (see
also part (1) of this
lecture series).

·
Background readings: Christiano-Fisher
(JECD, 2000), Ken Judd’s textbook.

3.
Estimation of
DSGE models (the handout makes some references to these notes
on model solution and here is a note on the appropriate
acceptance rate for the MCMC algorithm.

· James Hamilton, Time Series Analysis.

·
Christiano-Trabandt-Walentin, ‘DSGE
Models for Monetary Policy’, chapter in Friedman and Woodford’s Handbook of
Monetary Economics, 2011 (sections 3.3.3 and 5).

4.
Features of basic New Keynesian model
without capital and with flexible labor markets needed for assignment
#9. (For a more detailed handout, see handout#1
and handout#2
and also my handbook chapter. To study
Ramsey optimal policy in the NK model, see this
and for an even more detailed version, see this.)

5.
Introducing financial
frictions into the New Keynesian DSGE Model.

· Microfoundations
for the Costly State Verification (CSV) approach.

·
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
(forthcoming, AER). This url has the CMR manuscript, as
well as a carefully documented (by Ben Johannsen) set
of codes for reproducing the main results in the CMR.

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

·
Open economy version
of the model.

6.
Alternative
Approaches to the Labor Market.

· Critical review of the current
standard approach in DSGE models: sticky wages. The lecture notes for this are
a continuation of the notes in part 4 above.
You may find it useful to play with the Dynare code
for the sticky wage model, which is here.

· Building on the Diamon-Mortensen-Pissarides search/matching approach, particularly on the
DSGE approach pioneered by Walsh and others. The manuscript on which this
discussion is based is here.
Lecture notes will be posted later this week.

7.
Monetary policy and asset
prices. (Christiano-Ilut-Motto-Rostagno, background manuscript;
and section 3.2 of handbook chapter).

· News and inflation targeting.

·
Using Ramsey optimal policy as a benchmark for evaluating a policy
rule.

**Afternoon Sessions**

Apart from illustrating various points and concepts from the
lectures, the computer exercises explore the following additional substantive
topics:

1) The
sensitivity of the dynamic response of inflation and output to the persistence
properties of shocks.

a) Make
precise the NK concepts of ‘insufficient aggregate demand’ and ‘excessive
aggregate demand’ (see section 3.4 of handbook chapter).

2) The
Taylor principle (see section 3.1 of handbook chapter).

a) The
rationale for the principle in the standard NK model.

b) The
Taylor rule moves the interest rate in the right direction in response to
‘standard’ shocks, but does not move it far enough.

c) Optimal
monetary policy and the Taylor principle.

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).

b) News
shocks may imply that the monetary authority implementing the Taylor principle
moves the interest rate in the wrong direction (section 3.2).

**Assignment #7 (**the
exercise makes some references to these notes)

Introduction
to model solving with Dynare using the real business cycle model.

**Assignment #9**** **

This assignment works heavily with the Clarida-Gali-Gertler model, which is developed here and also in
the text of assignment #9.

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