Lecture Notes

Know the long-run relation between money and inflation and the short-run facts about monetary transmission that any model must explain. Understand the quantity equation, money demand and the opportunity cost of money, and why central banks moved from monetary aggregates to interest rates.

Explain why intrinsically useless money is valued, and build the two workhorse ways of putting money into a dynamic general-equilibrium model: money in the utility function and cash in advance. Derive superneutrality, the Friedman rule and the welfare cost of inflation.

Solve a monetary model with flexible prices, show monetary neutrality, and study how the price level is determined under money-supply rules and interest-rate rules. Understand price-level indeterminacy under an interest-rate peg and the role of the Taylor principle. Implement the model in Dynare.

Derive the New Keynesian Phillips curve from Calvo price setting step by step, relate its slope to the frequency of price changes and to real rigidities, and extend the framework to sticky wages. Confront the model with micro evidence on price setting and macro evidence on the Phillips curve.

Assemble the canonical three-equation New Keynesian model, define the natural rate and the output gap, derive the closed-form responses to monetary and technology shocks, and characterise determinacy under interest-rate rules. Solve and simulate the model in Dynare.

Derive the welfare-based loss function of the New Keynesian model, characterise optimal policy under discretion and under commitment, and explain the divine coincidence, inflation bias and stabilization bias. Compare optimal policy with simple rules.

Interpret Taylor rules as descriptions of and prescriptions for policy, estimate them, and understand their pitfalls. Compare strict and flexible inflation targeting, price-level targeting, average-inflation targeting and nominal-GDP targeting, and analyse them in a New Keynesian model.

Derive the Galí–Monacelli small-open-economy New Keynesian model, understand the roles of the terms of trade, the exchange rate and CPI versus domestic inflation, and compare domestic inflation targeting, CPI inflation targeting and an exchange-rate peg. Discuss pass-through, dollar pricing and the policy dilemmas of emerging markets such as Korea and Bangladesh.

Explain why the external finance premium depends on borrower net worth, derive the financial accelerator, and understand bank-capital and risk-taking channels of monetary policy. Build a reduced-form financial accelerator in Dynare and confront it with evidence on credit spreads.

Analyse liquidity traps in the New Keynesian model, understand why the lower bound makes recessions deeper, and evaluate forward guidance, quantitative easing, negative rates and fiscal policy at the lower bound. Explain the forward-guidance puzzle and its resolutions.

Use the government budget constraint to link monetary and fiscal policy, classify policy regimes as active or passive (Leeper, 1991), and understand the fiscal theory of the price level. Analyse the inflation tax on nominal debt and apply the framework to the 2021–23 inflation.

Understand how household heterogeneity changes the transmission of monetary policy. Decompose the consumption response into direct and indirect effects, derive the two-agent (TANK) model analytically, and see why high marginal propensities to consume (MPCs) and the distribution of liquid wealth are central to Heterogeneous-Agent New Keynesian (HANK) models.

Write a linear DSGE model in state-space form, evaluate its likelihood with the Kalman filter, combine it with priors, find the posterior mode and sample from the posterior with Metropolis–Hastings. Understand identification, model comparison and the estimated medium-scale models used by central banks. Implement the procedure by hand in MATLAB and with Dynare's estimation command.

Understand the identification problem in measuring the effects of monetary policy, and compare recursive VARs, narrative shocks, high-frequency identification and local projections. Interpret the price puzzle, information effects and the empirical evidence that DSGE impulse responses should match.

Connect the theory of the course to how central banks operate: independence and mandates, communication, inflation expectations, operating frameworks and balance sheets, and the measurement of inflation risk. Evaluate the evidence on inflation targeting and the lessons of the 2021–23 inflation.