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"While there has been considerable progress in quantitative macroeconomic modelling, most of the work in this area assumes that financial markets function perfectly and that financial institutions are merely a veil over real activity. To address the current crisis from both a positive and normative perspective, accordingly, it is necessary to integrate the relevant frictions in capital markets within contemporary macroeconomic analysis. The objective of this course is to describe the work that has been done to date in this area and also to characterize what is left to do.
The course will begin by discussing the micro-foundations of capital market frictions that give rise to key phenomena such as the external finance premium, balance sheet constraints on borrowing, and liquidity shortages. We will then move to general equilibrium and describe the financial accelerator, a theory of feedback between the financial and real sectors. Along the way we will discuss how financial institutions fit into the picture. We will then integrate the approach into a contemporary quantitative business cycle model and discuss the implications both for how the model captures the data and for policy analysis. In addition to discussing the implications for conventional monetary policy (i.e. interest rate setting), we will also analyze non-conventional monetary policies, e.g. direct credit market interventions, etc. Finally, we will extend the analysis to the open economy and consider the implications for sudden stops and for the appropriate policy response to these kinds of phenomena."
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