Our goal in this paper is to replicate the model of Gertler and Karadi (2011) and to give an elaborate overview of the way in which this model works. Instead of showing the final results, we provide a step-by-step overview of all the necessary calculations and derivations that lead to the ultimate model. Our last objective is to explain the relevance and the impact that the paper of Gertler and Karadi had. First, we describe the model with separate sections for the different agents that play a role in the model: households, financial intermediaries, intermediate goods firms, capital producing firms, retail firms, and the government (including the central bank). Secondly, we perform a Taylor approximation and import out model into Matlab. Thirdly, the model is analysed and the results are given. Fourthly, the impact of the Gertler and Karadi paper is discussed.
Table of Contents
1 Introduction
2 Model Description
2.1 Households
2.2 Financial Intermediaries
2.3 Credit Policy
2.4 Intermediate goods firms
2.5 Capital Producing firms
2.6 Retail Firms
2.7 Resource constraint and government policy
3 Log-linearization and the steady state relations
3.1 The Equilibrium
3.1.1 Equilibrium equations
3.2 Approximation
4 Model Analysis
4.1 The parameters
4.2 Model analysis
5 Discussion
5.1 Impact of the Gertler and Karadi (2011) paper
5.2 Criticism
6 Conclusion
7 Appendix: Taylor Approximations
7.1 Euler - optimal savings consumption
7.2 Stochastic Discount Rate
7.3 Arbitrage
7.4 Labour supply
7.5 Optimal leverage ratio
7.6 Growth rate of bank’s net wealth
7.7 Optimal utilization rate
7.8 Production Function
7.9 Net capital
7.10 Capital Accumulation
7.11 Fisher Relation
7.12 Effective Capital
7.13 Wages
Objectives & Research Focus
This paper aims to replicate the DSGE model of unconventional monetary policy developed by Gertler and Karadi (2011). The primary goal is to provide a comprehensive, step-by-step breakdown of the underlying economic agents, derivations, and the linearization process, which are essential for understanding the model's response to financial market disruptions.
- Detailed analysis of economic agent behavior including households, financial intermediaries, and firms.
- Replication of the log-linearization and steady-state derivation process.
- Evaluation of how credit policy interventions affect economic outcomes during a crisis.
- Investigation of model responses to various shocks, such as technology, wealth, and capital quality shocks.
Excerpt from the Book
2.2 Financial Intermediaries
The financial intermediaries obtain deposits from households and lend these to non-financial firms; so they make sure that the money flows from savers to investors. They hold long term assets which are paid for with short term liabilities, these liabilities are larger than their capital, so they create leverage. This leverage leads to agency costs, which is discussed later on. Furthermore, investments banks as well as commercial banks are part of the financial intermediaries.
The intermediary balance sheet is given by:
QtSjt = Njt + Bjt+1 (6)
With:
Qt : relative price of each claim
Sjt: quantity of financial claims on non-financial firms that the intermediary holds
Njt: amount of wealth intermediary j has at the end of period t
Bjt+1: deposits the intermediary obtains from the households
Chapter Summaries
1 Introduction: Provides context on unconventional monetary policy as a response to the 2008 financial crisis and states the research objective.
2 Model Description: Details the theoretical setup of the DSGE model, describing the behavior and constraints of households, financial intermediaries, and various firms.
3 Log-linearization and the steady state relations: Outlines the mathematical process of transforming the non-linear system into a linearized model suitable for simulation.
4 Model Analysis: Examines the parameterization and model responses to various economic shocks using Matlab and the Dynare toolkit.
5 Discussion: Assesses the scholarly impact of the original Gertler and Karadi paper and reviews external criticism regarding its assumptions.
6 Conclusion: Summarizes the effectiveness of the replicated model and suggests directions for future research regarding risk hedging and endogenous leverage.
7 Appendix: Taylor Approximations: Lists the detailed mathematical derivations for the linearized equations used in the model.
Keywords
DSGE model, Unconventional monetary policy, Financial intermediaries, Agency problem, Credit policy, Log-linearization, Taylor expansion, Interest rate spread, Capital quality shock, Leverage ratio, Macroeconomics, Financial frictions, Economic crisis, Monetary policy instrument, Investment dynamics
Frequently Asked Questions
What is the primary focus of this paper?
The paper focuses on replicating and explaining the quantitative DSGE model of unconventional monetary policy originally proposed by Gertler and Karadi (2011).
What are the central themes discussed in the work?
The work centers on how financial intermediaries, constrained by agency problems, operate within a macro-economic framework, and how central bank credit interventions can mitigate crisis-driven economic contractions.
What is the core research objective?
The objective is to provide a transparent, step-by-step documentation of the model's structure, the derivation of equilibrium equations, and the methodology required for numerical simulation.
Which scientific methodology is applied?
The authors apply structural economic modeling, specifically a dynamic stochastic general equilibrium (DSGE) approach, followed by log-linearization and first-order Taylor expansions to enable computational analysis.
What does the main body of the paper cover?
It covers the mathematical modeling of economic agents, the construction of steady-state relations, the numerical implementation of shocks, and a critical discussion of the model's real-world applicability.
Which keywords best describe this research?
Key terms include DSGE model, unconventional monetary policy, financial intermediaries, agency problems, and financial frictions.
How is a "crisis" simulated in the model?
A crisis is simulated primarily through a negative shock to the quality of capital, which negatively impacts the balance sheets and net worth of financial intermediaries, thereby increasing risk premiums.
What role do financial intermediaries play in this model?
They serve as crucial conduits for credit flow between savers (households) and investors (firms), and their ability to extend credit is constrained by their equity capital and an agency problem.
Why is the credit policy intervention considered important?
The analysis demonstrates that active credit policy by the central bank can moderate the decline in output and investment during times of financial market distress.
- Quote paper
- Colin Tissen (Author), Wiktor Owczarz (Author), 2017, A Step-by-Step Overview of Gertler's and Karadi's "Model of Unconventional Monetary Policy", Munich, GRIN Verlag, https://www.grin.com/document/376747
