Formulation, Estimation and Policy Analysis with Dynamic, Stochastic General Equilibrium Models

By Lawrence J. Christiano

**Overview**

The
objective is to review the basic New Keynesian model and the extensions that
are currently under development. The
course is aimed at a broad audience, including people actively doing research
with DSGE models, as well as people interested in seeing what these models are
about and what they are used for. There will be afternoon homework sessions,
which are not required to follow the lectures. The purpose of the homework
sessions is to give students hands-on experience solving, estimating and
analyzing the models discussed in lectures. We will use the software, Dynare version 4, to do the computations, though no experience
with Dynare will be assumed.

**Lectures**

1) The
consensus, medium sized New Keynesian (NK) DSGE
model.

2) Introducing financial frictions into the NK Model.

a)
Microfoundations for
the Costly State Verification (CSV) Approach to Financial Frictions.

b)
Integrating CSV
into an NK model and the results of Bayesian estimation of the model using US
and EA data.

a) (Very) brief additional
discussion:

i) CSV in a Small Open Economy Model and CSV in model with risky banking. (Discussion based on papers by Zeng and by Hirakata, Sudo and Ueda.)

ii) An
alternative approach to financial frictions: Two-period
financial friction model of Gertler-Kiyotaki, Handout

3) Introducing
unemployment into the NK Model

a)
Two approaches requiring minimal changes: Christiano-Trabandt-Walentin
and Gali.

b)
Alternative approaches based on
search and matching.

4) Implications of the zero lower bound on the nominal rate of interest: The deflation spiral, the government spending multiplier, quantitative analysis of the role of the zero bound in US data, 2008 and 2009, and other topics….

5) Monetary policy and asset
prices.

a) News
and inflation targeting.

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

**Afternoon Sessions**

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

1) The Taylor principle

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.

2) Ramsey equilibrium: interpretation of
‘inflation targeting’ and a benchmark for policy analysis.

3) The HP filter as a way to estimate
the output gap.

4) Bayesian estimation of a model.

**Assignment #7**

Relevant background:

Review of
log-linearization strategy for solving models.

News about future
technology shocks.

Section
3, Handbook chapter (see
below).

Text for distribution:

http://faculty.wcas.northwestern.edu/~lchrist/course/assignment7.pdf

http://faculty.wcas.northwestern.edu/~lchrist/course/assignment7ans.pdf

http://faculty.wcas.northwestern.edu/~lchrist/course/assignment7.htm

code to be placed on a subdirectory with name assignment7:

http://faculty.wcas.northwestern.edu/~lchrist/course/rbc.zip

http://faculty.wcas.northwestern.edu/~lchrist/course/dynare4instructions.m

http://faculty.wcas.northwestern.edu/~lchrist/course/cgg.zip

**Assignment #8**

Relevant background:

http://faculty.wcas.northwestern.edu/~lchrist/course/optimalpolicyhandout.pdf

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

http://faculty.wcas.northwestern.edu/~lchrist/course/assignment8ver4.zip

The following text should be
distributed as hard copy: http://faculty.wcas.northwestern.edu/~lchrist/course/assignment8.htm

**Assignment #9**** **

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

http://faculty.wcas.northwestern.edu/~lchrist/course/assignment9ver4.zip

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.

Unemployment:

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?