Financial Frictions and the Macroeconomy


By Lawrence J. Christiano




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.

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

d)    A moral hazard approach to financial frictions

i)       Two-period financial friction model of Gertler-KiyotakiHandout

ii)    Using the model to think about unconventional monetary policy.

2)    Implications of the zero lower bound on the nominal rate of interest.

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. 

3)    Monetary policy and asset prices.

a)    News and inflation targeting.

b)    Using Ramsey optimal policy as a benchmark for evaluating a policy rule. 

4)    Introducing unemployment with imperfect labor market insurance into the NK Model

a)    Revisiting Lucas’ cost of business cycles.

b)    Alternative approaches: Gali, search and matching.

c)    Using unemployment data to estimate the output gap.

Afternoon Sessions

 Apart from giving students hands-on experience with the quantitative analysis of models, the two homework exercises allow us to discuss the following topics: 

1)    Empirical methods

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 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).



Assignment #8

The pdf file contained in the following zip file should be available in hard copy. The zip file itself should be placed in a directory labeled assignment8

The following text should be distributed as hard copy:


Assignment #9 

The text for this assignment should be distributed in hard copy, and it is the pdf file in the following zip file:

The zip file should be placed in a folder labeled assignment#9


Background readings

 The main reference for the course is my chapter with Trabandt and Walentin, in the forthcoming Handbook of Monetary Economics, edited by Friedman and Woodford.


 Christiano, Trabandt and Walentin, Involuntary Unemployment in a Business Cycle Model


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.

Christiano, Trabandt and Walentin (2009): Financial and labor market frictions in a small open economy model of Sweden. (Handout)


Government spending and the zero bound: 

Christiano, Eichenbaum and Rebelo (2009) When is the Government Spending Multiplier Large?