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					  Financial Factors in Business
             Cycles
             Lawrence Christiano
                Roberto Motto
              Massimo Rostagno

              November 23, 2007

Presented by: Bob Baden and Sanchita Mukhergee
                        Agenda
•   Questions
•   Model Overview
•   Introduce Shocks
•   Agents
    –   Goods Production
    –   Capital Producers
    –   Entrepreneurs
    –   Households
    –   Banking
• Monetary Policy
• Flow Timing
• Resource Constraints
              The Questions

• Are there shocks that originate in financial
  markets (i.e., ‘bubbles’, ‘irrational
  exuberance’), and do these contribute to
  business cycle fluctuations?
• Do financial markets play an important role in
  the propagation of nonfinancial market
  shocks?
• How, if at all, should policy react to financial
  market shocks?
        Model Overview

                  Firms
        Banks



                  Factor         Capital
                  Markets       Producers

 HP
Money
        HH


                Entrepreneurs
               Model Overview

                              Firms
              Banks


  Deposits                    Factor       Capital
                              Markets     Producers

                      Labor
 HP
Money
              HH


                          Entrepreneurs
         Currency
                   Model Overview
    Transactions              Loans
    and Services
                                           Firms

             Banks              Labor

Loans
                         Liabilities
              Deposits                     Factor        Capital
                                           Markets      Producers
                                   Labor
  HP
 Money
                   HH


                                        Entrepreneurs
            Currency
                   Model Overview
    Transactions              Loans
    and Services
                                           Firms

             Banks             Labor
                             and Capital
Loans
                         Liabilities
              Deposits                     Factor                 Capital
                                           Markets               Producers
                                   Labor
  HP
 Money
                   HH                        Capital
                                                        Used
                                                       Capital          New
                                                                       Capital

                                       Entrepreneurs
            Currency                                               Own
                                                                  Capital
                   Model Overview
                                                                         Consumption
    Transactions                                                           Goods
                              Loans                        Output
    and Services
                                           Firms
                                                                      Investment
                                                                        Goods
             Banks             Labor               Labor and
                             and Capital          Capital Rental
Loans
                         Liabilities
              Deposits                     Factor                     Capital
                                           Markets                   Producers
                                   Labor
  HP
 Money
                   HH                        Capital
                                                            Used
                                                           Capital          New
                                                                           Capital

                                       Entrepreneurs
            Currency                                                   Own
                                                                      Capital
                   Model Overview
                                                                         Consumption
    Transactions                                                           Goods
                              Loans                        Output
    and Services
                                           Firms
                                                                      Investment
                                                                        Goods
             Banks             Labor               Labor and
                             and Capital          Capital Rental
Loans
                         Liabilities
              Deposits                     Factor                     Capital
                                           Markets                   Producers
                                   Labor
  HP
 Money
                   HH                        Capital
                                                            Used
                                                           Capital          New
                                                                           Capital

                                       Entrepreneurs
            Currency                                                   Own
                                                                      Capital
                   Model Overview
                                                                         Consumption
    Transactions                                                           Goods
                              Loans                        Output
    and Services
                                           Firms
                                                                      Investment
                                                                        Goods
             Banks             Labor               Labor and
                             and Capital          Capital Rental
Loans
                         Liabilities
              Deposits                     Factor                     Capital
                                           Markets                   Producers
                                   Labor
  HP
 Money
                   HH                        Capital
                                                            Used
                                                           Capital          New
                                                                           Capital

                                       Entrepreneurs
            Currency                                                   Own
                                                                      Capital
                                                                                     The Action is in the
    Transactions              Loans                        Output
    and Services
                                           Firms
                                                                      Investment
                                                                        Goods
             Banks             Labor               Labor and
                             and Capital          Capital Rental
Loans




                                                                                         15 Shocks
                         Liabilities
              Deposits                     Factor                     Capital
                                           Markets                   Producers
                                   Labor
  HP
 Money
                   HH                        Capital
                                                            Used
                                                           Capital          New
                                                                           Capital

                                       Entrepreneurs
            Currency                                                   Own
                                                                      Capital




  • Goods Technology: λf,t, t, μ*z,t , σ‫,א‬t
  • Capital producers and entrepreneurs: μY,t, ζi,t, τoilt,
    γt, σt
  • Demand: ζc,t, gt
  • Banking and Money demand : χt, xbt, ξt
  • Monetary policy: εt
                                                                         Consumption




                                                                                            Goods Production
    Transactions                                                           Goods
                              Loans                        Output
    and Services
                                           Firms
                                                                      Investment
                                                                        Goods
             Banks             Labor               Labor and
                             and Capital          Capital Rental
Loans

              Deposits
                         Liabilities
                                           Factor
                                           Markets
                                                                      Capital
                                                                     Producers
                                                                                       Standard Dixit-Stiglitz Framework for
  HP
 Money
                   HH
                                   Labor
                                             Capital
                                                            Used
                                                           Capital          New
                                                                           Capital
                                                                                                  Final Goods
                                       Entrepreneurs
            Currency                                                   Own
                                                                      Capital




    Final output:                                                                                                        (1)
    jth intermediate good:
                                                                                                                         (2)


    Fixed costs growth rate:                                                                                             (3)
    Labor, homogeneous
                                                                                                                         (4)
    and differentiated:
    Calvo sticky prices:                                                                        where                    (5)
    Optimize discounted
                                                                                                                         (6)
    profits:
                                                                         Consumption
    Transactions                                                           Goods
                              Loans                        Output
    and Services




                                                                                       Capital Producers
                                           Firms
                                                                      Investment
                                                                        Goods
             Banks             Labor               Labor and
                             and Capital          Capital Rental
Loans
                         Liabilities
              Deposits                     Factor                     Capital
                                           Markets                   Producers
                                   Labor
  HP
 Money
                   HH                        Capital
                                                            Used
                                                           Capital          New
                                                                           Capital

                                       Entrepreneurs
            Currency                                                   Own
                                                                      Capital




            New installed capital:
            Time-t profits:

            Capital producer’s problem solves:
            Evolution of aggregate
            stock of physical capital
    Transactions              Loans
    and Services




                                                                                 Entrepreneurs
                                           Firms

             Banks             Labor
                             and Capital
Loans
                         Liabilities
              Deposits                     Factor                 Capital
                                           Markets               Producers
                                   Labor
  HP
 Money
                   HH                        Capital
                                                        Used
                                                       Capital          New
                                                                       Capital

                                       Entrepreneurs
            Currency                                               Own
                                                                  Capital




         Utilization cost function:
                              Firms




  Deposits
              Banks



                              Factor       Capital
                                                      Households
                              Markets     Producers

                      Labor
 HP
Money
              HH


                          Entrepreneurs
         Currency




  Preferences:


                                                                   (15)

                                                                   (16)
  Uses & sources of funds:
  Asset accumulation equation:                                     (17)



                                                                   (18)
  Demand for labor:
  Calvo wage setting:
  Inflation:                                                       (19)
    Transactions              Loans
    and Services
                                           Firms



Loans
             Banks


              Deposits
                                Labor



                         Liabilities
                                           Factor        Capital
                                                                    Banking
                                           Markets      Producers
                                   Labor
  HP
 Money
                   HH


                                        Entrepreneurs
            Currency




    Working capital loans finance
    wage payments and capital rental costs:
    Loans, savings deposits, and                                              (7)
    time deposits are subject to:
    Liquidity constraint:                                                     (8)
    Liabilities = HP Money:                                                   (9)
    Working capital loans:                                                    (10)
    Total demand deposits:                                                    (11)

    Transaction services:                                                     (12)
    Excess reserves:                                                          (13)
    Net source of funds:
                                                                              (14)
                           Flow Timing
       Endowment   Begin                End           Begin       End
HH     Monetary    Currency      Money Injection      Goods Mkt Dep P+Int
       Base        Bank Deposits Buy Goods            Proceeds  Time P+Int
                                 Buy HP Money
       Labor                     Wage Payments
                                 Producer Profits
                                 Securities Payoffs
                                 Lump Transfers
                                 to or from
                                 Entrepreneurs
                                 Lumpsum Taxes

Bank               HH Deposit
             Resource Constraint
Final goods market clearing:



Government consumption:
The End
                   Model Overview
                                                                         Consumption
    Transactions                                                           Goods
                              Loans                        Output
    and Services
                                           Firms
                                                                      Investment
                                                                        Goods
             Banks             Labor               Labor and
                             and Capital          Capital Rental
Loans
                         Liabilities
              Deposits                     Factor                     Capital
                                           Markets                   Producers
                                   Labor
  HP
 Money
                   HH                        Capital
                                                            Used
                                                           Capital          New
                                                                           Capital

                                       Entrepreneurs
            Currency                                                   Own
                                                                      Capital

				
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