Formulation, Estimation and Policy Analysis with DSGE Models
By Lawrence J. Christiano
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.
1) The consensus, medium sized New Keynesian (NK) DSGE model.
2) 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 version of Gertler-Kiyotaki financial friction model, (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.
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).
Introduction to model solving with Dynare using the real business cycle model.
(A little background on linearization as a solution method.)
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 just-released 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 (JPE, 2011) When is the Government Spending Multiplier Large?