Lectures at Doug Laxtonís Workshop on Hot Topics in Macro Modeling, Washington DC, March 14-15, 2011

Financial Frictions in Monetary DSGE Models

By Lawrence J. Christiano

Introductory remarks

1)    Introducing financial frictions into the New Keynesian DSGE Model.

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

b)    Integrating CSV into a very simple GE setting.

c)     Integrating CSV into a large-scale 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.

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

2)    Financial frictions in the intermediation sector, exposited in two-period settings (sections 3, 4, 5 of reading, handout).

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).

3)    Implications of the zero lower bound on the nominal rate of interest (manuscript).

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. 

4)    Monetary policy and asset prices. (Background manuscript)

a)    News and inflation targeting.

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

 

Background reading on DSGE models and monetary policy:

 

Lawrence J. Christiano, Mathias Trabandt, and Karl Walentin, DSGE Models for Monetary Policy Analysis, In Benjamin M. Friedman, and Michael Woodford, editors: Handbook ofMonetary Economics, Vol. 3A, The Netherlands: North-Holland, 2011, pp. 285-367.