Economics 861.01

Monetary Theory I

Spring 2009


LAST UPDATED: October 27, 2009


Classes: Tuesday and Thursday, 12 PM

Office Hours: After class

Location: Department

Professor Matteo Iacoviello
Administration Building
, 470
Tel: 552-3689
Web page:



Course Description, Course Materials, Course Requirements, Reading List, Additional Information



This course covers models of Money demand, recent developments in the foundation of a role for Monetary policy in affecting the real economy, and issues in the formulation and conduct of Monetary policy.



Course Description

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This is a graduate course in Monetary Economics. We will study issues related to money, credit and the macroeconomy in general.



Course Materials

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I will make copies of my lecture notes available. Four books are recommended:

Woodford, Michael, 2003, “Interest and Prices”, Princeton University Press

Walsh, Carl E., 2003: Monetary Theory and Policy, Cambridge: MIT Press, Second Edition.

Burkhard Herr and Alfred Maussner (2004), Dynamic General Equilibrium Models: Computational Methods and Applications, Springer-Verlag. Berlin.

DeJong, David N. and Chetan Dave (2007), Structural Macroeconometrics, Princeton University Press


On VARs, a book worth looking at is:

Enders, Walter, 1995, “Applied Econometric Time Series, John Wiley



Course Requirements

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The requirements of the course are that:


1.                  You complete the homework assignments that I will give you. In order to complete these assignments, you will have to learn how to simulate dynamic general equilibrium models. 

2.                  You write a short paper on a topic of my/your choice.

3.                  You give a presentation on a paper from of your choice (pertaining to Monetary economics, not necessarily from the reading list, but still unpublished)

4.                  You attend the Macro seminar at BC


Total grade will be as follow:

45% homework assignments (3 ASSIGNMENTS IN TOTAL)

35% short paper

20% presentation



Due dates will appear below:









DSGE models





DSGE models





DSGE models

Files to run VARS














Maximum Likelihood





Maximum Likelihood















Incomplete Markets





Incomplete Markets





Incomplete Markets





Incomplete Markets





Incomplete Markets





Incomplete Markets





Multi-sector models





Multi-sector models












Xiaoping Chen: Nicholas Bloom, (2009)

Ekin Ustun: Mendoza, AER forthcoming
















Shahed Khan: Gali, Lopez-Salido and Valles (2007)

Mikhail Dmitriev: Barsky House and Kimball (2007).






Xinhao Dong: Justiniano & Primiceri (2008), AER

Kimiaki Shinozaki: Lansing (2009)












Brent Bundick: Curdia and Woodford (2009)

Isaiah Hull: Gertler and Karadi (2009), "A Model of Unconventional Monetary Policy,"

Mario Arend Serrano: Gertler and Kiyotaki (2009)















Reading List

NOTE: A star * denotes absolutely required readings. It refers to paper that we discussed in class or that are strong complements/substitutes to those papers. In addition to the lecture notes, You should plan to read all the required papers before the comprehensive exam.  Class notes will not be enough.

Papers denoted with # are instead available for presentation in class.

In most of the papers you can find a link to the (working paper version of the) paper. You are encouraged to find the published version of the paper or its most recent version on the author’s website.

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Topics for the short paper


1)    Goods versus Asset Price Inflation persistence: Some papers (e.g. Benati QJE) have documented that CPI inflation persistence has gone down, but what has happened to house price inflation (or inflation in the price of other assets?) throughout the same period. There is room here for a model, or for a rigorous econometric analysis that documents the facts

2)    Uncertainty shocks and consumer spending: It is everywhere: the idea these days (2009) being that when uncertainty rises, consumption goes down. Maybe yes (in partial equilibrium), but how much? Construct a rigorous measure of how much uncertainty has gone up (see e.g. Nick Bloom’s work). Then take any partial equilibrium incomplete markets model and simulate an exogenous increase in uncertainty (keeping mean income unchanged). What would happen to consumption and savings?

3)    Uncertainty shocks and consumer spending part 2: Same as above, but using the perspective of a consumer/firm that can spend or invest in productive assets

4)    Asset price shocks and spending: The last two recessions seem intimately related to asset price shocks (both house prices in 2008 and stock prices in 2001 and 2008). In the past, this relation was not so evident. Room here for a nice VAR study pre and post 1980s or so…



1. Linking Data and Economic Models

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Stock, J. H., and M. W. Watson, "Business Cycle Fluctuations in US Macroeconomic Time Series," in M. Woodford and J. B. Taylor, eds., Handbook of Macroeconomics, Vol. 1a (Amsterdam: North-Holland, 1999).

Woodford, Chapter 1.

Kydland, Nobel Lecture, AER

Prescott, Nobel Lecture, JPE



* Herr and Maussner, Chapters 1 and 2, and Section 3.3 of Chapter 4

* De Jong and Dave, Chapters 1, 2, 3

* Fernandez-Villaverde, J., Rubio-Ramirez, J., T.Sargent and Mark Watson (2007), “A;B;C’S (AND D)’S OF UNDERSTANDING VARS”, American Economic Review, June 2007

* Chari, VV, Patrick J. Kehoe and Ellen R. McGrattan (2004): “A Critique of Structural VARs Using Real Business Cycle Theory” (see also the discussion by Lawrence Christiano of the same paper available at )



* Uhlig, Harald (1997) “A Toolkit for Analyzing Nonlinear Dynamic Stochastic Models Easily''

* Ireland, Peter (2001), “Technology Shocks and the Business Cycle: An Empirical Investigation”, Journal of Economic Dynamics and Control, 25, 703-19

* Schmitt-Grohe, Stephanie and Martin Uribe. “Solving Dynamic General Equilibrium Models Using a Second-Order Approximation to the Policy Function.” Journal of Economic Dynamics and Control 28 (January 2004): 755-75.

* Jermann, Urban (1998), “Asset Pricing in Production Economies”, Journal of Monetary Economics, 41, 257-75.




2. Maximum Likelihood Estimation

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* De Jong and Dave, Chapters 4 and 9

* Canova, Fabio and Luca Sala (2009), “Back to Square One: Identification Issues in DSGE Models”, JME

* An, Sungbae, and Frank Schorfheide (2007), “Bayesian analysis of DSGE models”, Econometric Reviews, 26:2, 113-172.

* Chari, V.V., Patrick Kehoe and Ellen McGrattan, 2006, “Business Cycle Accounting,” Federal Reserve Bank of Minneapolis Staff Report 328, revised February.


3. Vector Autoregressions

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* Enders, W., “Applied Econometric Time Series”, John Wiley and Sons, Chapter 5

* Christiano, Lawrence, Martin Eichembaum and Charles Evans (2000), "Monetary Policy Shocks: what have we Learned and to what End?'', in J.Taylor and M.Woodford (eds.), Handbook of Macroeconomics

* Angeloni, Ignazio, Anil Kashyap and Benoît Mojon and Daniele Terlizzese, (2002) "Monetary Transmission in the Euro Area: Where Do We Stand?". Journal of Money, Credit and Banking

Uhlig, H. (2001), "What are the Effects of Monetary Policy on Output: Results from an Agnostic Identification Procedure'', JME




4. Incomplete Markets Models

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* Herr and Maussner, Chapters 5 and 6

* Huggett, Mark, 1993. "The risk-free rate in heterogeneous-agent incomplete-insurance economies," Journal of Economic Dynamics and Control, Elsevier, vol. 17(5-6), pages 953-969

* Aiyagari, Rao, 1994. "Uninsured Idiosyncratic Risk and Aggregate Saving," The Quarterly Journal of Economics, MIT Press, vol. 109(3), pages 659-84, August.

* Per Krusell & Anthony A. Smith & Jr., 1998. "Income and Wealth Heterogeneity in the Macroeconomy," Journal of Political Economy, University of Chicago Press, vol. 106(5), pages 867-896, October.

* Heathcote, Jonathan, Kjetil Storesletten and Gianluca Violante, (2009), “Quantitative Macroeconomics with Heterogeneous Agents”, Annual Review of Economics

* Kiyotaki, Nobuhiro, Alex Michaelides and Kalin Nikolov (2007) “Winners and Losers in Housing Markets

* Young, Eric R. (2006), “Approximate Aggregation.”, mimeo, University of Virginia

# Bloom, Nick (2009), “The Impact of Uncertainty Shocks”, Econometrica

# Bloom, Nick, Max Floetotto and Nir Jaimovich (2009). “Really Uncertain Business Cycles.”

# An, Sungbae; Chang, Yongsung, and Kim, Sun-Bin: Can A Representative Agent Model Represent A Heterogeneous Agent Economy?, AEJ Macro

# Mendoza, Enrique; “Sudden Stops, Financial Crises And Leverage: A Fisherian Deflation Of Tobin's Q”, AER forthcoming,

# Favilukis, Jack, Sydney Ludvigson, and Stijn Van Nieuwerburgh. (2009). “Macroeconomic Implications of Housing Wealth, Housing Finance, and Limited Risk-Sharing in General Equilibrium.”, Unpublished.



Codes to solve incomplete markets models

Code to approximate an AR(1) process using a Markov chain (from Liungqvist-Sargent) markovappr.m


To solve Deaton-Huggett-Aiyagari model. (Save in Matlab directory all files below)


MAIN FILE: aiyagari1.m

To simulate agents’ decision rules, call either: aiyagari1_sim.m, aiyagari1_sim2.m, aiyagari1_sim3.m

(Aiyagari1_sim3 is faster than Aiyagari_sim2 or aiyagari_sim, but they all serve the same purpose. The file llnenforce.m  is also needed and called by the _sim files);

To implement Howard improvement algorithm, you also need aiyagari1_hwd.m

Note that to find the market clearing rate you will need a simple loop outside the m file that finds the market clearing interest rate, but this is not implemented.



To solve a version of the Krusell-Smith model.

MAIN FILE: krusell1.m

To simulate agents’ decision rules, call: krusell1_sim.m (also need krusell1_hwd.m)

Note that to find the equilibrium actual law of motion you will need to run the krusell1.m file more than once, until the regression coefficients b0, b1 and b2 have converged.




5. Multi-sector Models

* Iacoviello, Matteo, and Stefano Neri (2007), “Housing Market Spillovers: Evidence from an Estimated DSGE Model

# Barsky, Robert, Christopher L. House, and Miles Kimball (2007), “Sticky Price Models and Durable Goods”, American Economic Review

Bouakez, Hafedh, Emanuela Cardia, and Francisco Ruge-Murcia (2005), "The Transmission of Monetary Policy in a Multi-Sector Economy," mimeo.

Davis, Morris A., and Jonathan Heathcote (2005), "Housing and the Business Cycle," International Economic Review, 46, 3, 751-784.

# Fisher, Jonas (2007), Why Does Household Investment Lead Business Investment Over the Business Cycle? (REVISED January, 2006) , JPE

Horvath, Michael, (2000), "Sectoral Shocks and Aggregate Fluctuations," Journal of Monetary Economics, 45, 69-106

* Lawrence J. Cristiano & Terry J. Fitzgerald, 1998. "The business cycle: it's still a puzzle," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q IV, pages 56-83.

* Christiano and Fisher (2003), NBER working paper 10031, Stock Market and Investment Good Prices.

* Greenwood, Jeremy, and Hercowitz, Zvi. (1991) “The Allocation of Capital and Time over the Business Cycle.” J.P.E. 99 (December 1991): 1188–1214.

* Greenwood, Jeremy, Zvi Hercowitz, and Per Krusell (2000), "The Role of Investment-Specific Technological Change in the Business Cycle." European Economic Review, 44, (January), 91--115.

Whelan, Karl (2003), "A Two-Sector Approach to Modeling U.S. NIPA Data," Journal of Money, Credit, and Banking, 35(4), 627-656, August.



6. Money in Flexible Price Environments     

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* Walsh, Carl, Monetary Theory and Policy, Chapters 2 and 3

* Cooley, Thomas, and Gary D. Hansen (1995), Money and the Business Cycle, Chapter 3 in "Frontiers of Business Cycle Research'', Thomas Cooley, editor

* Cooley, Thomas, and Gary D. Hansen (1989), "The Inflation Tax in a Real Business Cycle Model", American Economic Review, 79, 4, 733-748.





7. Money in Models with Nominal Rigidities

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* McCallum, Bennett (2001), "Should Monetary Policy Respond Strongly to Output Gaps?'', AEA Papers and Proceedings, May 2001

* Rotemberg, Julio J., and Michael Woodford (1997), "Interest Rate Rules in an Estimated Sticky Price Model" (link to WP version), Chapter 2 in Monetary Policy Rules, J.Taylor eds.

* Galí, Jordi, Mark Gertler, J. David Lopez-Salido, (2002), "Markups, Gaps, and the Welfare Costs of Business Fluctuations, ''NBER Working Paper No.w8850

# Jordi Galí & J. David López-Salido & Javier Vallés, 2007. "Understanding the Effects of Government Spending on Consumption," Journal of the European Economic Association, MIT Press, vol. 5(1), pages 227-270, 03.

Rotemberg, Julio J., and Michael Woodford (1997), "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy'' (link to the WP version), in NBER Macroeconomics Annual 1997, Cambridge, MA: The MIT Press, pp.297 346.

# Davig, Troy, and David Leeper (2007), “Generalizing the Taylor Principle”, AER





# Smets, Frank and Raf Wouters, “Shocks and Frictions in U.S. Business Cycles: A Bayesian DSGE Approach”, AER, 2007, June

* Christiano, Lawrence, Eichembaum, Martin, and Evans (2005), Nominal Rigidities and the Dynamics Effects of a Shock to Monetary Policy, Journal of Political Economy

# Justiniano, Alejandro, and Giorgio Primiceri (2008), The time varying volatility of Macroeconomic Fluctuations , AER 2008

* Carvalho, Carlos (2006) "Heterogeneity in Price Stickiness and the Real Effects of Monetary Shocks," Frontiers of Macroeconomics: 2, 1.





* Rubio-Ramirez, Juan and Pau Rabanal (2005), Comparing New Keynesian Models of the Business Cycle : A Bayesian approach (pdf file).  Journal of Monetary Economics, 52, pp 1151-1166.

* Boivin, Jean, and Marc Giannoni (2003), "Has Monetary Policy Become More Effective?", NBER Working Paper no. 9459. (Pdf file)

# Boivin, Jean, and Marc Giannoni (2008), “DSGE Models in a Data-Rich Environment”, mimeo

Ireland, Peter N. (2001): "Sticky-Price Models of the Business Cycle: Specification and Stability," Journal of Monetary Economics 47: 3-18 (link: BC WP version).

Fuhrer, Jeffrey, (2000), "Habit Formation in Consumption and Its Implications for Monetary Policy" American Economic Review. (September 2000)






* Galí, J, and M.Gertler (1999), “Inflation Dynamics: A Structural Econometric Analysis”, Journal of Monetary Economics, vol. 44, nº 2, 195-222, 1999

* Benati, Luca (2007), “Investigating Inflation Persistence Across Monetary Regimes”, mimeo

Fuhrer, Jeffrey C., and G.R. Moore, (1995), "Inflation persistence" (JSTOR), Quarterly Journal of Economics 110, 127-159.

Christopher J. Erceg and Andrew T. Levin (2003), “Imperfect credibility and inflation persistence”, Journal of Monetary Economics, Volume 50, Issue 4, May 2003, Pages 915-944.

Bils, Mark and Peter J.Klenow (2004), “Some Evidence on the Importance of Sticky Prices”, Journal of Political Economy




8. Optimal Monetary Policy     

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* Clarida, R., J. Galí, and M. Gertler (1999), ''The Science of Monetary Policy: A New Keynesian Perspective'', Journal of Economics Literature, 37, 1661-1707.

* Walsh, Chapter 4, Section 5

* Christopher J. Erceg, Dale W. Henderson, Andrew T. Levin (2000), Journal of Monetary Economics 46, 281-313, "Optimal monetary policy with staggered wage and price contracts''.

* Schmitt-Grohe, S. and M. Uribe, 2001a, ''Optimal Fiscal and Monetary Policy under Sticky Prices,'' draft, University of Pennsylvania

* Schmitt-Grohe, S. and M. Uribe, 2001b, ''Optimal Fiscal and Monetary Policy under Imperfect Competition,'' draft, University of Pennsylvania

* Clarida, Richard, Jordi Galí, and Mark Gertler (2000): "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," Quarterly Journal of Economics 115: 147-180

* Woodford, Michael, (1999), "Optimal Monetary Policy Inertia," August 1999 [Also available as NBER working paper no. 7261.]

Giannoni, Marc, and Michael Woodford (2002), "Optimal Interest-Rate Rules: I. General Theory,", mimeo

* Giannoni, Marc, and Michael Woodford (2002), "Optimal Interest-Rate Rules: II. Applications," , mimeo

* Woodford, Michael (2001), "The Taylor Rule and Optimal Monetary Policy'' January 2001 [Shorter version published in: American Economic Review 91(2): 232-237




9. Interactions between Fiscal and Monetary Policy

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* Woodford, Michael (1995), “Control of the Public Debt: A Requirement for Price Stability?" NBER working paper no. 5684, July 1996.

* Leeper, Eric M. (1991). “Equilibria Under 'Active' and 'Passive' Monetary and Fiscal Policies.”, Journal of Monetary Economics 27, February, 129-147.

# Christiano, Larry, Martin Eichenbaum and Sergio Rebelo (2009). “When is the Government Spending Multiplier Large?”, mimeo

David B. Gordon, and Eric M. Leeper (2002), "The Price Level, the Quantity Theory of Money, and the Fiscal Theory of the Price Level'', NBER Working Paper No.w9084, July 2002




10. Financial Factors and the Business Cycle

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Financial Frictions and the Transmission Mechanism

# Marvin Goodfriend, Bennett T. McCallum, “Banking and interest rates in monetary policy analysis: A quantitative exploration”, Journal of Monetary Economics, Volume 54, Issue 5, July 2007

* Iacoviello, Matteo (2005), “House Prices, Borrowing Constraints and Monetary Policy in the Business Cycle”, American Economic Review, May

# Christiano, Lawrence, Roberto Motto, and Massimo Rostagno (2009), “Financial Factors in Business Fluctuations”, mimeo

# Gilchrist, Simon, Albero Ortiz and Egon Zakrasjek, “Credit Risk and the Macroeconomy: Evidence from and Estimated DSGE Model”, mimeo, 2009.

# Curdia, Vasco, and Michael Woodford (2009), “Conventional and Unconventional Monetary Policy”, mimeo

# Campbell, Jeff, and Zvi Hercowitz (2006), “The Role of Collateralized Household Debt in Macroeconomic Stabilization”

# Jermann, Urban, and Vincenzo Quadrini (2006). "Financial Innovations and Macroeconomic Volatility," NBER Working Papers 12308, National Bureau of Economic Research, Inc.

# Lansing, Kevin (2009), Speculative growth and overreaction to technology shocks, mimeo, San Francisco Fed

Bernanke, Ben S., Mark Gertler, and Simon Gilchrist (2000), "The Financial Accelerator in a Quantitative Business Cycle Framework'', in Handbook of Macroeconomics, Volume 1C, edited by John Taylor and Michael Woodford (Elsevier).



Monetary Policy and Asset Prices

Bernanke, Ben S., and Mark Gertler (2001), "Should Central Banks Respond to Movements in Asset Prices?'', American Economic Association Papers and Proceedings, May, 91, 2, pp.253-257.

Piazzesi, Monika, and Martin Schneider (2006), “Inflation Illusion, Credit and Asset Prices”, mimeo

Lettau, Martin and Sydney Ludvigson (2003), “Understanding Trend and Cycle in Asset Values: Reevaluating the Wealth Effect on Consumption”, NBER Working paper 9848 (EFG, AP)



Banks and Business Cycles

# Gertler, Mark, and Peter Karadi (2009), “A Model of Unconventional Monetary Policy”, mimeo, NYU

# Gertler, Mark, and Nobuhiro Kiyotaki (2009), “Financial Intermediation and Credit Policy in Business Cycle Analysis”, mimeo, prepared for the Handbook of Monetary Economics



Additional Information

This is a link to my webpage containing resources on how to simulate dynamic stochastic models using Dynare



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