Advanced Macroeconomics: Monetary and Fiscal Policy in DSGE Models of the Business Cycle

Florin O. Bilbiie, HEC Paris Business School

The aim of this course is to familiarize students with policy-relevant macroeconomic research. The course will focus on monetary and fiscal policy issues
in dynamic stochastic general equilibrium (DSGE) models of the business cycle under imperfect competition and flexible and sticky prices. Topics covered
will include: equilibrium determinacy under alternative interest rate rules and
the role of sunspot fluctuations; empirical evaluation; optimal monetary policy;
commitment, discretion and delegation; asset prices and monetary policy; the
eects of government spending and the role of distortionary taxation; the fiscal
theory of the price level. Two main extensions of the basic framework will be
studied: limited asset markets participation and product creation, destruction
and variety.
There is no textbook as such for this course: I will provide lecture notes to
accompany the articles on the reading list. One book that reviews most of the
material - and that will be our reference book throughout the course is
Woodford, M., 2003, Interest and Prices: Foundations of a Theory of
Monetary Policy, Princeton University Press
A summary of my own view of this framework can be found in a lecture given
at College de France in May 2008, hosted by the College Chair in Economics,
Roger Guesnerie.
Assessment. You will have to present one of the starred papers in the list
below (in 15 minutes), write a brief referee report, and solve a take-home final
exam.

Course outline with readings

1. Review of DSGE framework/RBC models with flexible prices:

shortcomings for addressing monetary policy issues. Monetary neutrality and
classical dichotomy under flexible prices. Imperfect competition. The cashless
economy: monetary policy without money.
Woodford, Chapters 1 and 2.
Romer, The New Keynesian Synthesis, JEP
*Ball and Romer, Sticky Prices as Coordination Failure, AER
2. Monetary policy in a DSGE model with sticky prices. Equilibrium determinacy and sunspots, the Taylor Principle.
Woodford, Chapter 3 and 4.
Clarida, R., J. Gal, and M. Gertler, 1999, The Science of Monetary Policy:
a New Keynesian Perspective, J. Econ. Lit., 37, 1661-1707
Yun, T. 1996, Nominal Price Rigidity, Money Supply Endogeneity, and
Business Cycles , J. Monetary Econ.
Benhabib, J., S. Schmitt-Grohe, and M. Uribe 2001 "Monetary Policy and
Multiple Equilibria," American Economic Review 91
Lubik, T. and Schorfheide F. 2003 Computing Sunspot Equilibria in Linear
Rational Expectations Models J. Econ. Dynam. Control.
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3. Empirical implications of DSGE models with sticky prices.

Fuhrer, J. and Rudebusch, G. 2004, "Estimating the Euler Equation for
Output", Journal of Monetary Economics
Gal, J. and Gertler, M. 2001, "Inflation dynamics: a structural econometric
approach", Journal of Monetary Economics
*Lubik, T. and Schorfheide, F. 2004 Testing for Indeterminacy: An Application to U.S. Monetary Policy American Econ. Rev.
Clarida, R., J. Gal, and M. Gertler 2000: Monetary Policy Rules and
Macroeconomic Stability: Evidence and Some Theory, Quart. J. Econ.115:
147-180
Bilbiie and Straub Asset Markets Participation, Monetary Policy rules and
the Great Inflation, under revision for Review of Economics and Statistics
Christiano, Eichenbaum and Evans. Nominal Rigidities and the Dynamic
Eects of a Shock to Monetary Policy, Journal of Political Economy
Smets, Frank and Wouters, Rafael, Shocks and Frictions in U.S. Business
Cycles: A Bayesian DSGE Approach, American Econ. Rev.
4. Optimal monetary policy, relative price dispersion and the welfare costs of inflation and fluctuations. Second-order approximations
vs Ramsey policy.
Woodford Chapter 6
Khan, King and Wolman 2003 "Optimal monetary policy" Review of Economic Studies
*Yun 2005 "Optimal Monetary Policy with Relative Price Distortions" American Economic Review
Schmitt-Grohe and Uribe "Optimal monetary policy under monopolistic
competition" JET
Schmitt-Grohe and Uribe "Optimal monetary policy under sticky prices"
JMacro
Adao, Correia and Teles, Gaps and Triangles, REStud
5. Time inconsistency, commitment, discretion and timeless optimal policy. Monetary policy delegation in DSGE models.
Woodford Chapter 7 and 8.
Woodford 2003: Optimal Interest Rate Smoothing, Review of Economic
Studies,
Walsh. 2003 "Speed Limit Policies: The Output Gap and Optimal Monetary
Policy" American Economic Review
Jensen, 2002 Targeting nominal income growth or inflation, American Economic Review
6. Endogenous entry and product variety: implications for monetary and fiscal policy.
Broda and Weinstein, 2007 Product Creation and Destruction: Evidence
and Price Implications, NBER Working Paper
*Bilbiie, Ghironi and Melitz, 2007, Endogenous entry, product variety and
business cycles, NBER Working Paper
Bilbiie, Ghironi and Melitz 2007 Monetary Policy and Business Cycles With
Endogenous Entry and Product Variety, NBER Macroeconomics Annual
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Bergin and Corsetti 2007 Towards a theory of firm entry and stabilization
policy, NBER Working Paper
*Shleifer, A., Implementation Cycles, JPE
Aghion and Howitt, Endogenous Growth (the chapter on cycles).
7. Limited asset markets participation: implications for monetary
and fiscal policy.
Mankiw, N. G. 2000, "The Savers-Spenders Theory of Fiscal Policy," American Economic Review
Gal, J., J. D. Lpez-Salido and J. Valls, 2007 Understanding the Eects
of Government Spending on Consumption, Journal of the European Economic
Association
Bilbiie, F. O., 2007, Limited Asset Markets Participation, Monetary Policy
and (Inverted) Keynesian Logic, Journal of Economic Theory
Bilbiie, Meier and Mueller, 2007, What Accounts for the Changes in U.S.
Fiscal Policy, Journal of Money, Credit and Banking
Bilbiie and Straub 2007, Asset Market Participation, Monetary Policy Rules
and the Great Inflation, IMF Working Paper
8. Fiscal policy: the eects of government spending shocks under
flexible and sticky prices. Distortionary taxation. The Fiscal Theory
of the Price Level.
Blanchard, O.J. and Roberto Perotti, 2003, An Empirical Characterization of the Dynamic Eects of Changes in Government Spending and Taxes on
Output, Quarterly Journal of Economics
Baxter and King. 1993 Fiscal Policy in General Equilibrium, American
Economic Review
Linnemann, L. and A. Schabert, 2001, "Fiscal Policy in the New Neoclassical
Synthesis", Journal of Money, Credit and Banking
Bilbiie, F. 2008, "Nonseparable utility, fiscal policy puzzles and inferior
goods" Journal of Money, Credit and Banking
Cochrane, 2000 Money as Stock, Journal of Monetary Economics
Woodford. 1999 Control of the public debt: a requirement for price stability?
NBER Working Paper
Christiano and Fitzgerald, Understanding the FTPL
Perotti, R. Fiscal Policy in good times and bad QJE
*Monacelli and Perotti, Fiscal Policy, Wealth Eects and Markups, Mimeo
Bocconi