New Keynesian Models and Financial Frictions
By Lawrence J. Christiano
We will develop the basic New Keynesian model in detail and review its key policy implications. The policy implications focus on getting aggregate demand to do the ‘right thing’, something that is not guaranteed, according to the New Keynesian model. We will then integrate the particular set of financial frictions proposed by Bernanke-Gertler-Gilchrist into the model. We will discuss how the introduction of these financial frictions alters conclusions about the sources of business cycle fluctuations and expands the set of policy questions that can be studied. We will then discuss other models of financial frictions, which are designed for thinking about the channels by which ‘unconventional monetary policy’ might improve economic outcomes.
1) Introductory remarks.
2) The New Keynesian model.
b) Assignment #9, question 1.
c) For a discussion of this material, see the handbook chapter referenced below. In addition the material on ‘news’ shocks is taken from my August 2010 Jackson Hole paper.
3) Introducing financial frictions into the New Keynesian DSGE Model.
i) The model
ii) The importance of risk shocks.
iii) The response of monetary policy to an increase in interest rate spreads.
d) An open economy version of the model with financial frictions.
a) Two-period version of Gertler-Kiyotaki financial friction model, (section 3).
b) Hidden action (section 4). (For a dynamic version, and its implications for leverage restrictions, of this model, see.)
The main reference for New Keynesian models is my chapter with Trabandt and Walentin, in the 2011 Handbook of Monetary Economics, edited by Friedman and Woodford.
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 why it lasted so long.
Christiano, Motto, Rostagno (2012): Using the BGG model to understand the causes of economic fluctuations in the US in the past few decades.