Economics D16
Larry Christiano
Spring, 2000
Syllabus for 'Monetary Economics and Policy'
Homework #3
The purpose of this course is to review basic topics in monetary economics and in monetary policy. The grade will be determined by a combination of homeworks and a class paper. We will cover the following topics:
1. Optimal Monetary Policy Under Commitment.
2. Optimal Monetary Policy Without Commitment: The Markov Case.
3. Models of the Monetary Transmission Mechanism With Frictions.
(a) Sticky prices, wages, sticky portfolios (limited participation model)
(b) Frictions associated with imperfect credit markets.
4. The Operating Characteristics of Economies with Interest Rate Targetting Rules.
(a) Taylor Rules.
(b) Price level indeterminacy under interest rate peg and what it means
5. Monetary Policy With Heterogeneous Agents: Stefania Albanesi
(a) Optimal Policy.
(b) Policy Under Bargaining.
6. The Fiscal Theory of the Price Level (Cochrane, Sims, Woodford).
(a) Some Experiments Under Fiscal Theory (Christiano-Fitzgerald, Kocherlakota--Phelan).
(b) The cashless economy.
7. The Economics of the Zero-Bound Constraint.
8. Open Economy Issues.
9. Model Solving. As it is relevant, we will discuss model-solving methods.
Examples of questions we'd like to be able to answer:
What should the central bank's interest rate target be?
Why did inflation take off in the 1970s, and come down now? What can be done to prevent this from happening again?
What is the optimal degree of volatility in the price level?
How do we think of price level determination in a world where government money becomes less important (i.e., what happens to the value of a `dollar' if dollars start to vanish in importance?).
What is the role of fiscal policy versus monetary policy in determining the price level?
Do low interest rates inhibit a central bank from doing its job?
What is the appropriate response of monetary policy in the aftermath of a currency crisis?
Topic (i) establishes an important benchmark in the analysis of monetary policy, even though the commitment technology may not exist for achieving it in practice. Here, we will take into account that monetary policy is part of the overall government budget constraint in which expenditures must be financed with debt, money issuance and/or distorting taxes. Topic (ii) will address the more realistic case in practice, in which governments have limited ability to commit to future actions. Substantively, we will focus on whether the time consistency problem can account for the swings up and down in inflation experienced in recent decades (e.g., along the lines suggested in the classic Kydland-Prescott and Barro-Gordon papers). On a methodological level, we will review some of the analytic tools (principally, the Markov equilibrium concept) for thinking about economic environments like this. Topic (iii) will address issues in the emerging literature on the design of monetary policy rules. A key objective is the design of monetary policy rules that ensure economic stability, in particular, that ensure a determinate equilibrium. The concern with equilibrium determinacy reflects primarily the view that the most recent episode of poor monetary policy, the one that occurred in the 1960s and 1970s, reflects the implementation of a monetary policy rule that results in an indeterminate equilibrium. Topic (iv) will ask whether a tough, independent central bank with only an inflation mandate is sufficient to achieve price stability. The classic paper by Sargent and Wallance, 'Some Unpleasant Monetarist Arithmetic', says 'yes'. The recent literature on the 'Fiscal Theory of the Price Level' says 'no'. We will review this and other controversies raised by the recent Fiscal Theory literature.