Description and contextualization of the subject

The Monetary Markets course provides Master EAP students with the basic tools to understand monetary market issues. Background requirements include basic knowledge about (i) difference equations, (ii) dynamic optimization, (iii) descriptive statistics, (iv) time series analysis, (v) general equilibrium, (vi) monopolistic competition, (vii) calibration, and (viii) MATLAB. Knowledge attainment of these specific requirements is achieved during the first quarter of the master program.

This course starts analyzing the relationship between money, prices, interest rates and output using basic time series techniques that were introduced in the Quantitative Methods and Time Series Analysis course during the first quarter of the program. The time series analysis carried out in this course distinguishes a long-run perspective, where money is supposed to have no real effects (i.e. money neutrality hypothesis) from a short-run perspective, where changes in the quantity of money are expected to affect the behavior of real variables.

After this time series analysis, two prominent theoretical monetary models are introduced, solved, assessed and eventually used for monetary policy analysis. The two models belong to a large class of models called dynamic stochastic general equilibrium (DSGE) models used in modern Macroeconomics. The first model features flexible prices (i.e. a classical model) whereas the second introduces price stickiness (i.e. a Keynesian model). Solving DSGE models is not a trivial exercise. As a basic approach, it first requires a linearization of the model’s equilibrium conditions and then solving a linear rational expectation system of equations. This course gets deeper in the numerical solution techniques discussed in the Macroeconomics course took during the first quarter of the master program. More precise, the expected learning results are:

• This course teaches the student how to implement non-linear model solution techniques by using the two monetary models to illustrate them.

• Students will get familiar with specific MATLAB codes to solve the alternative monetary models introduced in this course. Computer seminars are programmed along the course to get familiar with both solution techniques as well as MATLAB codes used to find the numerical solutions.

• Once each model is solved, the student can assess their ability to replicate certain second moment statistics featuring business cycle stylized facts. In particular, one can evaluate whether the model is able to capture the actual comovement between nominal variables (money, inflation and nominal interest rates) and important real variables (such as output, consumption, investment and real wages). As a by-product, the student can simulate the impact of alternative monetary policies and assess their effects on both the real and the nominal side of the economy.

• Students will be able to identify the relative importance of both real and nominal rigidities. Moreover, she/he will be familiar with the analytical tools to understand both macroeconomic and monetary markets issues.



Student learning process will be monitored through a few homeworks, presentations, and a final exam. The formation of study groups is encouraged through the learning process in order to prepare for individual homeworks, presentations, and exams.

Ordinary call: orientations and renunciation

The evaluation system has four steps:

1. A homework showing student level of expertise in (i) collecting time series data from a relevant source (e.g. the St. Louis Federal Reserve Bank data set) and (ii) carrying out a time series analysis. The weight of this first task in the final grade is 10%.

2. A homework showing the student’s ability to solving and assessing monetary DSGE models. This second task also weighs 15% in the final grade.

3. Student’s presentation of a research paper in the classroom. The weight of this task is 15%, where half of this weight is decided by the professor and the remaining half is determined by other student anonymous opinions.

4. An exam at the end of the course representing 60% of the final mark.



The final exam will be at the classroom unless special circunstances require an alternative form of exam. This alternative exam will be announced in due time.

Extraordinary call: orientations and renunciation

The evaluation method is identical in the two opportunities to pass the course.

Temary

1. Evidence on money, prices and output

1.1. Basic correlations

1.2. Granger causality

1.3. Structural vector autoregression

1.4. Comovement

1.5. Homework 1 (Tutorial)



2. A classical monetary model

2.1. Introduction: review of the RBC model

2.2. The money-in-the-utility-function (MIU) model

2.3. The steady state

2.4. The linear approximation

2.5. Calibration and simulation results (Computer seminar)

2.6. Limitations of the MIU model and extensions



3. The New Keynesian monetary (NKM) model

3.1. The basic model

3.2. Linear approximation

3.3. Dynamics: analyzing the monetary transmission mechanism

3.4. Simulation exercises (Computer seminar)

3.5. Homework 2 (Tutorial)



4. Policy analysis in the NKM model

4.1. Introduction

4.2. Instrument rules: money-growth rules versus interest-rate rules

4.3. Targeting rules

4.4. Simulation exercises



5. Financial markets and monetary policy

5.1. Introduction

5.2. Interest rates and monetary policy

5.3. The term structure of interest rates

5.4. Macrofinance

Bibliography

Compulsory materials

- Galí, Jordi, Monetary Policy, Inflation and The Business Cycle (2008) Princeton University Press.



- Hamilton, J., Time Series Analysis (1994) Princeton University Press.



- Walsh, C. E., Monetary Theory and Policy (2003) 2nd ed., The MIT Press.



- Woodford. M. Interest and Prices, 2003, Princeton University Press.

Basic bibliography

• Walsh, Carl E., Monetary Theory and Policy (2010) 3rd ed., MIT Press.

• Vázquez, Jesús, Lecture Notes available at (https://egela2223.ehu.eus/).

In-depth bibliography

• Clarida, R., Galí J., and Gertler, M. (1999) The science of monetary policy: a new Keynesian perspective. Journal of Economic Literature 37, 1661‐1707.



• Galí, Jordi, Monetary Policy, Inflation and The Business Cycle (2008) Princeton University Press.



• Smets, F., & Wouters, R. (2007) Shocks and frictions in US business cycles: a Bayesian DSGE approach. American Economic Review 97, 586‐605.



• Woodford, Michael, Interest and Prices, 2003, Princeton University Press.