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50:27
Transcript
0:16
so so um so remember what has been
0:20
happening to the US economy as as as
0:23
economy and and it happens similarly
0:25
with a few lcks and leads and and
0:28
differences in sizes but around the
0:30
world in most economies around the world
0:32
as the economy began to reopen from
0:34
covid H we had a situation where we had
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0:38
sort of too much demand for Supply the
0:40
the potential output using the
0:42
terminology you'll have in the ISL NPC
0:45
model was slow in picking up because we
0:48
still had lots of bottlenecks in the
0:49
supply chains and and in different
0:52
sectors of the economy H some people
0:55
didn't didn't want to come back to work
0:57
to the labor force for a while and and
1:00
and so on so so the supply side was very
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1:03
still
1:04
impair ER not as impair as in the middle
1:07
of the covid in 2020 say but it's still
1:10
in pair while
1:12
demand was very strong because people
1:16
were fed up of being staying at home
1:18
they had saved a lot during the the
1:20
covid recession and they wanted to spend
1:23
okay and there had been lots of fiscal
1:25
support and monetary policy support and
1:27
so on so people feel wealthy and felt
1:29
rich
1:30
and and so they want to spend you know
1:33
if is there's a big demand but Supply is
1:36
not there that is starts introducing
1:38
inflationary pressures that's say we
1:40
have a a negative output a positive
1:43
output Gap output above potential output
1:45
that puts immediately inflationary
1:47
pressure that's what we learn from the
1:49
Philips curve and all that
1:51
okay and now for a while the the the FED
1:55
um did not want to react to this because
1:58
they thought that this was going to be
2:00
mostly a temporary phenomenon that
2:01
Supply would recover pretty rapidly and
2:04
that you know people would after taking
2:06
one trip well they wouldn't want to take
2:08
a second one fiscal support was winding
2:11
down and so on so they thought this
2:12
would go away and they didn't want to
2:14
sort of cool off the economy because
2:16
they thought they didn't want to fight a
2:17
temporary fight now as a result of new
2:20
shocks the war and things like that but
2:23
also that the initial call was not right
2:26
was incorrect that there was a lot of
2:28
inertia in demand and and and and that
2:31
that pickup in demand sort of lasted a
2:34
lot longer than I expected H is that
2:37
that inflation really began to rise and
2:40
the Fed was really CAU what is called
2:43
behind the curve know they needed to
2:45
they were they should have started at
2:46
least Expos it's easy to see it that way
2:49
they should have remember what you have
2:50
if you have an a situation where output
2:52
is above potential output the interest
2:54
rate is supposed to be rising so the FED
2:56
is supposed to be increasing the
2:58
interest rate but it didn't for a while
3:00
assuming that the forces that were
3:02
bringing potential output down and
3:04
demand up were so transitory when they
3:07
discovered that wasn't the case they had
3:09
to start catching up as a result of that
3:11
they began to hike interest very very
3:14
rapidly okay and the unusually rapidly
3:17
for economy like the US and the reason
3:20
there are many reasons why why policy
3:23
makers especially monetary policy makers
3:25
prefer to be gradualist meaning to move
3:28
things in smaller steps rather than in
3:30
one big Bank ER especially in the way up
3:34
no if if it is to cut rates they're very
3:36
willing to be very aggressive in cutting
3:38
rates but racing rates is something they
3:41
tend to be reluctant to do very very
3:43
rapidly and one of the main reasons
3:45
they're reluctant to do that very
3:47
rapidly is because something may break
3:49
in the process and there are certain
3:51
things are very important if they break
3:53
there are certain other things are not
3:54
very important if they break but one of
3:55
the things that is very important if
3:57
they break is Banks okay and and and
3:59
that's typically where you get run into
4:01
trouble when there is episodes of very
4:03
fast hikes in rates now because the US
4:07
banking sector especially the large
4:09
Banks were sort of very resilient they
4:12
had lot of capital and so on there
4:14
wasn't a lot of concern that that would
4:16
be an issue in the US because again the
4:17
the big Banks look very healthy uh
4:20
deposits were flowing out of big Banks
4:22
but it was happening all at a normal
4:24
Pace it's normal that deposits go out of
4:26
the banking sector when interest rates
4:28
are to rise uh but there was no sign of
4:31
major trouble well that changed a month
4:33
ago as you well know and something broke
4:35
finally no and that the major episode
4:37
there was the Silicon Valley Bank know
4:41
we Al saw a big bank bank run there and
4:44
eventually that bank collapsed and since
4:46
then things have looked a little more
4:49
complicated so here you have for example
4:52
a a Commercial Bank deposits as I said
4:55
as I said as the FED began to hike so
4:58
focus on the red line the FED began to
5:01
hike rates then H deposits began to
5:04
people began to move their money out of
5:06
deposit into US treasuries money market
5:09
funds things of that kind that was
5:11
normal okay and that didn't lead to a
5:14
big cut in lending which is what you
5:15
worried about when when Banks lose
5:17
funding but things began to change quite
5:20
rapidly well in the second half of 2022
5:23
this was perceived felt mostly by large
5:26
Banks and when deposits decline
5:28
gradually in large Banks that's not such
5:30
a big issue because deposits are not the
5:33
only funding source that that big banks
5:35
have they have many other sources of
5:37
funding H but then things that's what
5:40
happens this year things accelerated
5:43
very very quickly H this year and so
5:45
this is different this is a different
5:47
animal from this sort of very controlled
5:49
decline in deposits as interest we're
5:51
hiking this is a very sharp decline in
5:54
deposits okay uh so that's a problem
5:57
because that that's an avoid
6:00
will hit lending okay so that's when to
6:04
show up in terms of the moldes we have
6:06
had if you were to use your ISL MPC
6:09
model it would show up as an increas in
6:11
X remember we had premium and stuff like
6:13
that well that's a way you probably
6:15
could model what is happening right
6:18
now now one of the big as I said before
6:22
these are in different Scala so a small
6:25
Bank deposits on the left large Banks
6:28
deposit on the on the right
6:30
as I said before through most of of this
6:34
episode in which deposits were declining
6:37
in the in the banking
6:39
sector it was mostly a phenomenon that
6:42
was that that affected large Banks and
6:45
it was very grad okay but what happened
6:48
since a month ago is essentially small
6:50
and mediumsized Banks experien a very
6:53
large running deposits part of that went
6:55
to money market us treasuries and and
6:57
part of it you don't see different scale
6:59
and
7:00
but it went actually to large Banks it
7:01
was relocation it's called that's called
7:03
flight to Quality okay now even if if if
7:08
this has been a full relocation of of H
7:11
deposits from large bank to from small
7:14
Banks to large Banks and so no deposit
7:16
would have declined in the whole banking
7:18
sector that would have consequences for
7:20
the economy because these type of banks
7:22
don't lend to the same type of
7:23
people small Banks small especially
7:26
Regional Banks lend a lot to people that
7:31
to businesses and people that do not
7:33
have other sources of funding they tend
7:35
to be small businesses and so on the
7:37
only way they can get borrow is either
7:40
from the family or from a bank but they
7:42
cannot issue bonds and things like that
7:44
no and so they don't have other sources
7:46
of
7:48
funding and so that's the problem
7:50
because what you see here is naturally
7:52
when you start seeing deposits going out
7:54
there have been also H losses
7:57
experienced by the Banks because they
7:59
had to recognize the losses in the asset
8:01
side once they lost deposit is that they
8:03
had to cut lending and you can see here
8:05
what has been happening to lending large
8:08
Banks they began to slow down here but
8:10
it's a gradual slow down you have seen a
8:12
very sharp decline in lending over the
8:14
last three or four weeks okay so we're
8:17
in the early phases what we like to call
8:21
as described as a credit crunch okay and
8:27
um now that's a the problem as I said
8:30
before because those
8:33
banks these Banks Banks in Gray here are
8:36
the banks that lend primarily to small
8:39
and medium-sized businesses okay so you
8:42
see here the share of
8:43
commercial H and Industrial loans by
8:46
Bank size H and this is loans to small
8:49
businesses loan to larger business these
8:51
are the banks that are in grade before
8:54
below $250 billion and you see that that
8:57
they have a large share of loans to
9:00
small businesses okay so those sectors
9:03
are going to suff suffer a lot so
9:05
there's going to be a a contraction in
9:07
the economy and it's going to be very
9:09
concentrated on the small businesses
9:11
mediumsized businesses and so on and
9:13
again it's more problematic a
9:15
contraction in lending to those
9:17
businesses because they don't have
9:18
alternative sources of funding that's it
9:21
okay it's either return earnings the
9:24
family if it is really really small or H
9:29
ER
9:31
Banks again big corporations these guys
9:34
probably have are borrowing from 10
9:36
different banks and and and they have
9:38
issued corporate bonds and and they even
9:41
have commercial paper this a entirely
9:44
different life when you live here than
9:45
when you live
9:47
here H if you look by sectors that also
9:50
is going to have implications for
9:52
sectors so this is going to be clearly
9:54
contractionary but it's not going to be
9:56
equally contractionary it will depend on
9:58
the composition of your sectors and not
10:00
all sectors have the same share of small
10:03
businesses and and and mediumsized
10:05
businesses you see here the construction
10:07
services a very large share most of the
10:10
more than half of the businesses in
10:11
construction are really small or
10:13
mediumsized businesses okay H big
10:16
contract with utilities where sort of
10:18
they are all big businesses and so on
10:21
okay so so big dispersion and so this is
10:24
going to be a contraction is going to be
10:25
very felt is felt very strongly here at
10:28
the top
10:30
okay so that's what is happening right
10:32
now and from the point of view of the
10:34
aggregate essentially where we have gone
10:36
is from a path like this to a path like
10:39
that so the economy was overheating so
10:42
we need to slow down the economy there's
10:43
no way around that output was above
10:46
potential output that was causing
10:47
inflationary pressure we needed to bring
10:49
this stuff down and the economy was
10:51
slowing down but it was happening at
10:54
sort of a very slow pace and that was a
10:57
bit exas exasperating for the FED but it
11:00
was happening very very slowly among
11:02
other things because of the balance
11:04
sheets of the household sector and
11:06
corporations in general was so very
11:08
healthy but now things are accelerating
11:12
very quickly because once you produce
11:14
credit CR credit constraints and things
11:16
like that like that so of the same
11:19
declines in wealth that we were
11:21
experienced before that were dragging
11:22
aggregate demand down have a much larger
11:25
effect and so we're changing from some a
11:27
world that look like that to world it's
11:29
going to look a lot more like this and
11:32
that's tricky for the central bank
11:34
because now the FED needs to before
11:37
there was no way around they had to hike
11:38
interest rate H because the main problem
11:42
was inflation now they know that as they
11:44
hike interest rate they still need to
11:46
hike interest rate I think unless it is
11:47
a big mess ER because inflation is still
11:51
way above their target ER but they have
11:53
to be very worried that this stuff
11:55
doesn't become to
11:56
steep the things get to be very
11:58
nonlinear when the financial sector is
12:01
involved and and so probably that means
12:04
that on net they already did it in the
12:07
previous meeting everyone anticipated 50
12:09
basis points of hikes once svb happened
12:13
the bets went down dramatically and the
12:16
realization went down to 25 basis points
12:19
and so that's where we are H now now if
12:22
everything works as
12:23
plan and more or less that's a forecast
12:27
at this moment there isn't any panic and
12:28
so on
12:29
is that we're going to experience not a
12:31
technically a recession but significant
12:34
slowdown in in in the next quarters or
12:37
so okay so that that's that's what that
12:40
sort of the consensus expecting to to
12:44
see H as a result of all these combined
12:46
forces the effect that it still needs to
12:48
tighten because of aggregate demand
12:50
reasons and the very negative effect of
12:53
the credit crunch especially on certain
12:55
parts of the economy okay but that's
12:57
what if everything again it works as
12:59
plan means things continue to go Fairly
13:03
smoothly H then it's certainly not going
13:06
to be a a good year for economic
13:08
activity ER but it shouldn't be a
13:11
disaster either and that's sort of where
13:13
we are at and and the tension is well if
13:16
the financial crisis sort
13:18
of leaks into the larger Banks then then
13:23
these numbers are going to get a lot
13:24
worse of course but that's that's that's
13:26
a concern at the moment but uh but it
13:30
doesn't seem like the central scenario
13:33
now there are also some good news
13:35
happening because remember that the
13:37
problem we have the problem you have
13:39
comes from two sides one side is too
13:41
much demand and that the FED can affect
13:44
very quickly that's that's what it's
13:46
doing by hiking interest rate not as
13:48
quickly as they would like but still
13:51
they they have an impact on that but the
13:53
other problem was aggregate supply and
13:56
in particular is that the labor market
13:58
look very tight and remember when we did
14:00
the Philips curve and all that the labor
14:02
market is very critical in all that
14:04
process of generating inflation and so
14:06
on that's a reason you sort of try to
14:10
generate more unemployment essentially
14:11
to lower wage pressure because that
14:14
means less pressure on prices and so on
14:16
so forth and one of the problems is that
14:19
again looks is very nice in principle
14:22
that we have very low unemployment rate
14:24
but it's very difficult to sort of lower
14:26
wage pressure If unemployment is so low
14:31
having said this and this is the part
14:33
that I say is sort of Fairly good news
14:35
having said this in the mod we simplify
14:37
things and we just put an employment as
14:40
the only variable that could adjust and
14:41
that was important for wages as aside
14:43
from some institutional things in
14:45
practice there are many other indicators
14:47
and really what really matters is
14:48
employment what happens we took as a
14:51
fixed n we took a fixed the
14:53
participation rate and that's the reason
14:55
unemployment was the variable summarize
14:56
everything but what really puts pressure
14:59
on labor market is shortage of workers
15:02
if you have an unemployment rate that is
15:04
constant but there are lots of workers
15:06
have coming into the labor force and
15:08
that's not doesn't put as much pressure
15:10
on on wages and therefore less pressure
15:12
on inflation and this is exactly what we
15:15
beginning to see in the US economy and I
15:17
think that's very good news it gives us
15:18
hope that this inflationary process may
15:21
come down a little faster so this is
15:25
labor market participation remember so
15:27
this unemployment number
15:30
spike a lot but it under represented how
15:33
much contraction there was in labor in
15:35
employment and so on because many people
15:37
simply exit the labor force and those
15:40
remember we don't count as an employed
15:42
okay and so that happened it was a very
15:45
sharp decline in the in the labor force
15:48
in the labor participation rate so
15:50
decline in the labor force and then that
15:52
recovery is one of the things that
15:53
happened much slower than the FED
15:55
anticipated and that was part of the
15:57
mistake is they thought that this was
15:59
going to come back quickly and that for
16:02
potential output was going to rise very
16:04
quickly and it didn't that was one of
16:05
the the the mistakes the forast mistakes
16:08
but now it's clearly it's coming back to
16:10
levels that are sort of more consistent
16:12
with historical
16:15
levels if you look at the employment to
16:17
population ratio also big decline for
16:20
similar reasons but if you look at
16:21
employment to population ratio today is
16:24
clearly sort of getting back to the
16:26
trend it had before okay so so that's
16:30
that's very good news in the sense that
16:31
even if unemployment doesn't move a lot
16:34
this sort of reduces well it's good for
16:36
output expands and so on but it also
16:38
lowers the pre inflationary pressures in
16:41
the economy and another component that
16:44
actually that that I think I mentioned a
16:46
couple of times in in the lecture but is
16:49
immigration in in a market like the us a
16:52
lot of the labor forces comes from
16:54
immigration okay and and that stopped
16:56
for a while for a variety of reasons but
16:58
certainly Co had a a big effect so so
17:02
that meant sort of about
17:04
500,000 less people a year coming into
17:07
the US Labor Force and that has big
17:09
impacts especially in some sectors of
17:11
the economy okay lots of and and that's
17:14
clearly being fixed now okay we may have
17:18
other problems people may fight for
17:19
political reasons and the SS whatever
17:21
but from the point of view of macro this
17:24
is certainly helping okay and in fact if
17:27
you look at where the wage pressure is
17:30
really coming from in the US economy is
17:32
coming from those sectors where sort of
17:34
immigrants play a big role you know um
17:37
accommodation Food Services stuff like
17:40
that you see that there sort of wages
17:42
Rose pretty dramatically because there
17:44
was a massive shortage there for two
17:45
reasons one people didn't want to go
17:48
back to those sectors to work close
17:50
contact and stuff like that and the
17:52
other one is that the important flow of
17:56
supply of workers into that had sort of
17:58
slowed down quite dramatically okay so
18:01
that's where we're at and as a result of
18:04
all these good forces despite the fact
18:06
that we have very low
18:09
unemployment you can see that wage
18:11
pressure is beginning to decline in the
18:12
US okay so it was very high there but
18:16
those numbers are very distorted by
18:17
composition effects and stuff like that
18:19
but these were the numbers that were
18:21
very worrisome I mean with wage
18:22
inflation of 6% it's going to be very
18:24
difficult to bring inflation to 2% down
18:27
you need much lower wag inflation but
18:29
you see that that is beginning to
18:31
decline 2% is still too high for a
18:35
steady state if you want to go back to
18:36
2% inflation rate because you can have
18:39
an increase in real wage but that has to
18:40
be more or less aligned with the rate of
18:42
growth of
18:43
productivity which is much lower than
18:45
that I mean at best it's 1% one and a
18:47
half sometimes but so you could live
18:49
with three and a half% weight real
18:52
nominal wage growth but four four and a
18:55
half it's it's a bit too much
18:59
okay anyway so that's a that's that's
19:02
the state of economy any questions about
19:04
the state of economy open questions
19:07
no no you're happy with it I'm fine good
19:12
okay good so so what I want to next is
19:17
so this was a summary and I all that I
19:19
did here I did close economy economics
19:21
okay all the my description I didn't
19:23
need to tell you what was happening in
19:25
the rest of the world and so on that
19:27
would have been a lot harder to do if if
19:30
if this was Singapore for example
19:31
because Singapore depends a lot on the
19:33
rest of the world and it's very
19:34
difficult to tell a story that just
19:35
depends on what happen in Singapore the
19:37
US is pretty unique in that you can tell
19:40
most of the story based on what happens
19:42
in the US most not all but most of the
19:44
story and that's what I just did almost
19:47
anywhere else you need to think about
19:50
even if you're in Japan big economy and
19:52
so on effects will play a big role and
19:54
so when you describe the state of the
19:55
economy you're going to be talking about
19:56
the Yen very high very low or
20:01
not here you don't worry much about the
20:03
dollar but the US is very unique on
20:06
that I think no other country in the
20:08
world has that that feature okay so now
20:11
we're going to open up the economy and
20:13
again perhaps it's it's the least
20:16
important for the us but anywhere else
20:18
is tremendously important more so it's
20:21
becoming increasingly important for the
20:23
US it has been becoming increasingly
20:25
important for the US now we're in the
20:27
middle of a de globalization mess we
20:29
shall see where we end up so there has
20:31
been a bit of a reversion of a very
20:33
strong Trend towards integrating the
20:36
economies of the world through many
20:38
different channels and so I want to talk
20:40
about what are the key variables in the
20:43
when you integrate an economy to the
20:44
rest of the world and and and things of
20:46
that kind H I'm going to start with some
20:49
definitions what are variables are we're
20:51
going to be talking about that we
20:53
weren't talking about up to now so one
20:56
of the things that's going to be very
20:57
important in an open economy exchange
20:59
rate okay and here I'm giv you I'm going
21:02
to Define things very formally later on
21:03
but but but here you see an
21:06
example of the US dollar Visa the main
21:10
trading partners the US trades with many
21:13
different parts of the world and there's
21:15
an bilateral effects between those
21:17
things and this measure here is
21:19
something that weights by the amount of
21:21
trade that we have with different
21:22
economies of the world trace the
21:24
different effects and says well is the
21:25
dollar strong weak or whatever
21:29
this is a matter of convention there's
21:30
many ways you can no there are two ways
21:33
in which you can do it but we're going
21:35
to do it the following way what this
21:37
effects will reflect is the price of the
21:40
domestic currency in foreign currency
21:42
terms so that means when this goes up
21:46
means the dollar was becoming very
21:48
expensive okay and that's a that's a
21:51
very sharp I I'll get back to it but we
21:54
call that an appreciation of the
21:55
currency okay so here the the dollar was
21:58
becoming very expensive in terms of
22:01
other
22:02
currencies the opposite happened sort of
22:05
starting the second half of 2022 and now
22:08
we have some had some Cycles here during
22:11
this year but that's sort of that's
22:13
going to be a very important variable
22:14
the FX we call it the FX exchange
22:19
rate another variable that we haven't
22:21
talked about but but that is going to be
22:24
important here is is and and that
22:27
politicians argue a lot about it for
22:31
with the wrong arguments but but but
22:32
they do ER is the trades balance trade
22:36
trade balance of goods and services of
22:38
goods and services so this the trade
22:41
balance of goods and services is simply
22:44
a er um the difference between the
22:48
exports so what a country sells to the
22:50
rest of the world versus its import that
22:52
is how much it buys from the rest of the
22:54
world okay so this is monthly data for
22:58
the US
22:59
the US nowadays sort of runs a deficit a
23:03
trade balance deficit of the order of 7
23:06
70 billion dollars a
23:08
month that means it exports to the rest
23:11
of the world about S no 70 billion
23:14
dollar less than it Imports sorry sorry
23:18
yeah seven less than it Imports perfect
23:21
okay you have seen that this is
23:23
pretty H sustained
23:27
actually here look pretty balanced but
23:30
but but but the US on on on average has
23:33
a situation like that okay the US tends
23:36
to export less than it Imports and then
23:39
that's when politicians get all very
23:41
worked out and said you know this is
23:43
unfair competition from the rest of the
23:45
world and so on so forth I think in
23:47
general has very little to do with that
23:49
it has to do that with the fact that the
23:52
US likes to save less than the rest of
23:54
the world and and but but let me not get
23:57
into that and think much later in the
23:59
course but anyway that's the situation
24:02
for the
24:03
US this is obviously a blep that has to
24:06
do with covid and so on but you see that
24:07
we're now more or less back to to where
24:11
we were before this was a period
24:13
actually of lots of global political
24:16
tension because it had one counterpart
24:19
that was very big it was
24:20
China okay and it is called the the time
24:24
of the global
24:26
imbalances and that the US was learning
24:28
very large trade deficits and then China
24:31
in particular was running very large
24:33
trade surpluses and and so there were
24:34
lots of political quarters because of
24:38
that here you have a so obviously the US
24:42
has many many trading partners and with
24:44
respect to many of them it has very
24:46
large deficits so on net and here are
24:49
the main I rank the the 10 main net
24:54
deficits for the us so I don't know when
24:57
was this but anyway it looks like that
24:59
sort of for the
25:01
last eight or so
25:04
years remove Co it looks more or less
25:06
like this all the time and you see that
25:09
the US indeed large
25:11
large exports to China about $153
25:15
billion a year and it Imports about 536
25:19
billions a year so the net deficit is$
25:23
380 billion dollar a year and that's the
25:25
reason this is a big political thing
25:27
okay because it sounds
25:29
like a big deficit but there are other
25:30
countries with respect to Mexico 130
25:32
billion and so on the US exports a lot
25:35
more to
25:36
Mexico ER Vietnam a lot of what happens
25:39
from Vietnam is really Chinese exports
25:42
in this guys but but uh but there you
25:45
see it okay there are many others
25:47
Germany is always a a problem but uh a
25:50
problem for somebody that his deficit as
25:53
a problem
25:55
uh and so on okay
26:01
now that's a on the good side this is
26:04
this is this what I was saying here is
26:06
that you know one sense of openness is
26:09
on the goods and services Market that
26:11
you buy goods from the rest of the world
26:13
the rest of the world buys goods from
26:15
you sometimes these things are balanced
26:17
sometimes they're not H when at the
26:21
aggre level they're not balance for a
26:22
very long period of time unless you're
26:24
the US that often causes problems ER um
26:28
but at the bilateral level if you look
26:31
at any country we'll have situations
26:33
like this some country where they export
26:35
a lot to and import very little from and
26:37
vice versa but that's the way the US
26:40
looks another sense of openness which is
26:42
very important is financial openness no
26:47
meaning that you can also buy or save
26:50
using foreign assets or domestic assets
26:54
okay so you can buy a foreign asset
26:57
perhaps not directly or most of you
26:59
directly but you can do it through a
27:01
broker and so on you can buy foreign
27:03
assets or and foreigners buy lots of us
27:07
assets okay that's a sense of openness
27:10
in financial markets that you can buy
27:12
you're not stuck with your own your
27:15
country's financial asset you can also
27:17
invest in other Count's Financial assets
27:19
and vice
27:20
versa those things probably you how I
27:24
mean you notice trade openness a lot
27:26
more probably than financial openness no
27:29
because you're all the time buying
27:30
imported goods and stuff like that
27:34
H while you probably not involving lot
27:36
of transactions of international
27:38
financial instruments and so on but they
27:40
are very large okay so if Pension funds
27:45
and so on they're all involved in very
27:47
large transactions in fact transactions
27:48
in financial markets are an order of
27:50
magnitude larger than transactions in
27:52
the Goods Market very large and here you
27:55
have an example of a
27:58
by origin the the the you know foreign
28:01
Holdings of us
28:03
assets and this is in in in billions
28:07
so these guys here this is China and
28:11
Canada so have the largest and the UK
28:14
those have sort of you know in the order
28:16
of $2
28:18
trillion of us assets they're
28:21
holding Japan should be here also L A
28:23
there there it is
28:25
yeah now in these two countries
28:28
here a lot of those Holdings
28:32
actually well particularly in China more
28:35
than than in Japan in China is a little
28:37
less than than Japan
28:39
Japan they save a lot so they need to
28:42
buy lots of financial assets and the US
28:44
is as the main producer of financial
28:47
Assets in the world so they save a lot
28:49
on that but also the central bank
28:51
because of currency intervention and so
28:53
on buys lots of us
28:55
treasuries China this is mostly the
28:58
Central Bank buying US treasuries
29:00
foreign reserves okay large amount of
29:03
reserves Canada is private sector
29:05
Pension funds and so on for but you see
29:09
Brazilians also buy lots of assets from
29:12
the US again central banks play big
29:14
roles in all this Australia is less the
29:17
Central Bank much more private sector UK
29:20
is all private sector and so
29:22
on and then Europe okay but point of
29:25
that picture is that there's lots of
29:28
countries in the world resent of
29:30
different countries in the world that
29:31
buy us Financial assets and in big
29:33
amounts
29:35
okay I don't know what the total number
29:38
today is
29:46
probably actually let me not make up
29:48
that number you may find it
29:52
um but it is certainly in
29:55
the2 trillion dollar or something like
29:57
that of H assets held us assets held by
30:01
foreigners you can check it and tell me
30:05
it's probably
30:06
more here's the other way around us
30:09
residents Holdings of foreign assets
30:13
okay
30:15
ER you see us
30:18
us residents hold lots of Canadian
30:21
assets okay and mostly developed
30:24
economies but you have India China and
30:28
so on lots of Latino American
30:31
assets and so on okay so the US is so
30:36
it's not only that the rest of the world
30:39
demands us asset but us
30:43
residents perhaps not directly most of
30:45
you but indirectly demand lots of
30:47
foreign assets okay um there are some
30:51
very fascinating facts that happen here
30:53
because the type of assets that
30:54
foreigners tend to demand from the US
30:56
are very different from the ones that
30:58
us er um demands from the rest of the
31:02
world ER in fact one of the things that
31:06
that the reasons the US can afford
31:08
running those chronic trade
31:11
deficits is because it tends to get much
31:14
higher Returns on the asset it buys
31:15
abroad than foreigners get on the assets
31:18
they buy in the US and the difference
31:21
allows you to find sort of systematic
31:24
trade deficits and the reason for that
31:26
is a lot of the US assets that for buy
31:29
they do it for safety reasons they're
31:30
buying us treasure it's very safe
31:32
instrument just in case there is a big
31:34
mess they they want to have those assets
31:36
so it's it's almost for insurance reason
31:39
ER the US Treasures are sort of
31:42
perceived as the main safe Assets in the
31:44
world okay so they they hold it for for
31:47
that reason while the US mostly hold
31:50
assets abroad for a you know risky
31:54
Investments either foreign direct
31:56
investment or Equity stuff like that and
32:01
typically most fixed income investments
32:03
in the US a lot of it a lot of what you
32:05
see here is just us resident reaching
32:09
for
32:11
yield
32:13
Brazilian Sovereign bonds equivalence of
32:15
the US treasuries you know give you 9%
32:18
10% it's a lot higher than the US tends
32:20
to give H 14% even now and so on so so
32:25
so net the US tends to make
32:30
has less Assets in the rest of the world
32:32
than foreigners have of the US and it
32:34
still makes sufficiently more return
32:38
higher return on average on an asset it
32:39
holds from the rest of the world that it
32:41
has a surplus which which it can Finance
32:44
the trade deficit This is complicated
32:46
you don't need to know the details but I
32:48
to tell you what the kind of things are
32:52
happening so so there's three senses in
32:56
which you can have a a and of of
32:59
openness the two that I have described
33:01
implicitly already Goods in Goods Market
33:04
that you can
33:05
buy foreign goods and you can sell Goods
33:08
to the rest of the world and the second
33:10
one is financial markets which is what I
33:12
just described you can choose between
33:14
domestic and foreign assets the main
33:17
impediments to the forers typically are
33:19
tariffs and quotas and you have heard a
33:21
lot about tariffs and so on these days
33:25
ER the main impediment for financial
33:27
Market is what is called Capital
33:28
controls very rarely develop economies
33:31
impose Capital
33:33
controls but emerging markets do it
33:35
regularly okay H limit the amount of
33:39
especially Capital outflows when lots of
33:40
capitalist Le in the country they try to
33:42
stop you from doing more of that and and
33:46
they sometimes do it in the way in
33:48
because they they want to avoid the
33:50
micro instability that comes from the
33:52
big reversal of capital flows so they
33:54
don't let lots of capital flow in during
33:56
the boom just to prevent
33:58
a reversal later on that's capital
34:01
controls and there's a third way of
34:03
opening to the rest of the world H which
34:06
is Factor markets okay which is that
34:09
firms can choose location I mean some
34:11
plants we're seeing you know Japanese
34:14
plants that that that do not export
34:18
Toyotas from directly from
34:21
from from Japan they have the plant here
34:24
either in Canada or somewhere in the US
34:27
and they sell locally so that's that's
34:29
relocation of factors of production
34:31
Japanese Capital that relocates to some
34:33
place in Canada or in the US and labor
34:36
you can also have workers that move from
34:38
one place to the other that's another
34:41
form of openness no free Capital free
34:46
free Factor mobility in this part of the
34:50
course we're not going to talk about
34:51
this okay we're going to just we're
34:53
going to focus in the on these
34:56
two the first we're going to look at is
34:58
going to be a model of the Goods Market
34:59
and that's going to be very much H like
35:03
the islm but with an open economy and
35:07
then we're going to bring in interest
35:10
rate but now on you which is what
35:12
remember what we did in the closed
35:13
economy first we look at the Goods
35:14
Market then we look at interest rate
35:16
determination that was our LM and then
35:19
we put the things together we came up
35:20
with slm here the tricky thing is that
35:23
there's not only one interest rate there
35:25
are really two you have to decide
35:26
between the domestic and foreign
35:28
interest rate and then there's an
35:29
exchange rate in between which will also
35:31
affect so that's the reason it's going
35:32
to get a little more complicated because
35:34
you're going to be having two different
35:36
prices two different Goods you can buy
35:38
you can going to have also two different
35:40
assets you can buy okay and the effects
35:42
is going to affect all those things if
35:45
when whenever I say FS I mean thechange
35:48
rate
35:50
okay forign exchange that's the reason
35:52
sometimes called
35:55
FX now one thing that happens er er is
36:00
that because economies are so integrated
36:03
in in goods and financial markets is
36:06
that bus business Cycles tend to be
36:08
especially large one large large ones
36:10
tend to be very synchronized around the
36:11
world you see here Emerging
36:16
Markets sorry yeah this is the world
36:19
that's that's emerging markets and
36:22
that's advanced
36:23
economies you can see the kind of things
36:25
we discuss in the growth section which
36:27
is these countries tend to grow faster
36:29
than these countries because they're
36:31
catching up okay that's the reason
36:33
they're called emerging you know H but
36:37
at the level of business cycle they're
36:39
very synchronized I mean the 2008 2009
36:43
recession was a recession
36:44
globally this one doesn't have covid but
36:47
but well Co naturally was very
36:49
synchronized around the world but big
36:52
the the point I'm making here is that
36:54
once you're very integrated to the rest
36:56
of the world you're Al exposed to a new
36:58
source of shocks it may help you in many
37:00
instances but you're also exposed to
37:02
things that come
37:03
from the rest of the world and the
37:05
evidence is that business Cycles are
37:07
very synchronized it's very difficult
37:11
for the rest of the world to be immune
37:12
to us recession for example it's very
37:15
easy for the US to be immune to an
37:16
Argentinian recession that's that's a
37:19
different story but but but when things
37:22
are large invol the large economies
37:24
typically that will leak into the rest
37:26
of the world China has sort of changed a
37:29
little bit the composition used to be
37:30
the case that that was always the case
37:32
the if the us sankk then everyone sank
37:36
and and and and the and now you have
37:39
China which stabilizes it's a difference
37:41
it's not completely
37:43
correlated with with the US and so that
37:45
has been stabilizing actually for many
37:47
especially commodity producing economies
37:50
and so on but it's still the case big
37:52
mess is a big mess everywhere if the
37:53
economies were close there would be no
37:55
reason unless you have some saw you know
37:57
shock covid even if the economies were
37:59
completely closed would have been a mess
38:02
because you know it's as long as the
38:04
virus spread then it's a mess regardless
38:07
but that's not the case here this
38:08
recession was caused by a financial
38:10
shock in the
38:11
US okay and still the whole econ the the
38:15
global economy as a whole suffer a lot
38:18
so Things become very synchronized
38:19
because of
38:21
that another thing that has been
38:23
happening is that
38:25
everywhere again still we shall see
38:29
where we end up after this covid things
38:31
there was a slight reversion of that but
38:33
everywhere even the US which one of the
38:35
closest economies in the world one of
38:37
the closest of the significant economies
38:40
ER there has been a sort of there was a
38:42
steady Trend rise towards higher
38:45
integration to the rest of the world
38:47
okay and the same is happening in
38:48
financial markets it's just an order of
38:50
magnitude larger but but you see here in
38:53
the US you see that imports and exports
38:55
as a share of GDP they were both Rising
38:57
ing over time here shows you what I
39:00
showed you before which is the deficit
39:01
chronic deficit that the US has had but
39:04
still even exports have been rising for
39:07
a while
39:08
now this number here you know that about
39:13
the 20% of the US produced Goods 15% of
39:18
GDP the US has about 15% of of of GDP in
39:23
Imports and in exports some people use
39:25
that the sum for example of Imports plus
39:27
exports over GDP as a measure of
39:29
openness how open is an economy and it's
39:32
okay for comparisons but it's clearly
39:35
underestimate how open economies really
39:37
are I mean many of the goods that are
39:40
considered that that the US does not
39:43
import are produced domestically so they
39:46
don't count as part of imports or
39:47
anything their price is really
39:49
determined by International
39:51
competition okay the price of a of a
39:54
Ford is very different with foreign
39:57
compe I that not so we don't count the
39:59
fors produced here as Imports or
40:02
anything or and if would be part of the
40:06
nontradable not tradeable it wouldn't
40:08
part of this measure of openness but
40:10
it's clear that the price and even the
40:13
quality is being affected by exposure to
40:16
International competition okay so there
40:18
are very few sectors that are not really
40:19
exposed to International competitions
40:21
yeah haircuts they're not I mean you
40:24
know you're not going to unless you
40:26
leave sort of at
40:28
some country you know County at the
40:31
border of with Canada and there is a
40:33
town right on the side that that's
40:35
that's that's not going to happen
40:37
but okay so trend is upward and and and
40:42
uh even more so than than those numbers
40:46
suggest if you look across the world and
40:49
here is what I show you before is what I
40:52
said before is the US
40:54
actually it's is certainly look very
40:57
close relative to others if you look at
40:59
across large
41:01
economies Japan which is also a very
41:03
close economy for a variety of reasons
41:05
is still more open than the US UK little
41:09
Chile here but you know one thing that
41:13
this shows this Dimension here shows is
41:16
that the smaller you are the more open
41:18
you're likely to be and it makes sense
41:21
it's harder to produce all the goods if
41:23
you have you know a small
41:25
country and and and so so so that's
41:28
that's a pattern the smaller you are
41:30
controlling for a variety of
41:32
factors ER you tend to be more open you
41:35
need to Import and Export more import
41:39
more in particular uh now that pattern
41:45
is disrupted when you look in this
41:47
direction no so this all these
41:51
countries ER which are clearly much
41:55
larger than Chile in terms of GDP and on
41:59
ER have very high export ratios why do
42:03
you think that's the
42:12
case exactly they're in Europe so so you
42:17
know this Europe is very special Europe
42:20
as a whole is as close as the US so if
42:23
you look at the whole area together but
42:25
but there is lots of intra Europe
42:27
exports and imports especially in the
42:29
Euro Zone I mean you have lots of things
42:31
you have the same currency you just you
42:33
know it's it's right next door so so so
42:36
they're very open but they're very open
42:38
within Europe not so much with the rest
42:42
of the
42:43
world but this does a differ shate intra
42:46
Europe exports and imports versus total
42:50
and that's the reason you see these
42:51
numbers are very very large but even
42:53
here within here you see that the
42:55
smaller countries tend to be very open
42:58
much more open than than than bigger
43:00
countries
43:03
okay
43:06
good so H as as I said so
43:10
terminology um this picture looks very
43:12
similar to the picture I show you
43:14
earlier on but it's not there it was a
43:17
trade weighted H dollar and here is just
43:21
one particular bilateral exchange rate
43:24
which is the dollar yen exchange rate
43:26
what happens is is when the dollar
43:28
appreciates typically appreciates
43:29
against everything and so on that's the
43:30
reason the pictures look very similar
43:32
but this was pretty dramatic you know
43:34
there was a very sharp appreciation of
43:36
the of the dollar of well strike what I
43:41
said I'm so anyways this is the pattern
43:44
of the number of yens per dollars
43:47
meaning meaning that's we decided that
43:49
that's the way we're going to find the
43:50
exchange this the price of the domestic
43:52
currency in terms of foreign currency so
43:55
the price of the US dollar goes up up
43:58
when they pay you more yens per dollar
44:01
okay and and it went up very rapidly
44:02
from close to 100 to 150 that was
44:05
massive there were massive interventions
44:07
here because it was clear that this was
44:08
getting totally out of hand but but uh
44:12
but any so that was okay and we
44:15
say in this case so when a currency
44:18
gains in value we call that in terms of
44:21
other currencies there's no sense of a
44:23
currency gaining value in terms of
44:24
nothing it has to be in terms of other
44:26
currency that's what an exchange itate
44:27
is we say that the currency is
44:30
appreciating okay so in this case is the
44:33
nominal exchange rate so it's dollars
44:35
per dollars when the
44:38
dollar when the dollar is going up here
44:40
we say the dollar is appreciating
44:43
relative to the Japanese Yen okay that
44:45
means the dollar is becoming more
44:46
expensive they have to give you more
44:48
yens per dollar you can look at it from
44:50
the point of view of Japan and then the
44:53
picture would look the other way around
44:54
and it says in this same picture I know
44:56
that the Japanese yen is
44:58
depreciating relative to the US dollar
45:02
okay so depreciation is when your
45:03
currency loses value appreciation is
45:05
when your currency gains
45:12
value a k i mean if I tell you unless
45:16
you sort of more or less knows the
45:17
prices in the different places if I tell
45:20
you that that that the Japanese
45:23
ER the US buys 1030
45:27
Japanese Yen you can tell me and then I
45:30
ask you where would you like to buy your
45:32
car and assume that the car is the same
45:34
quality no transport cost and so on and
45:36
I tell you look the Japanese yen is give
45:39
you you you for each dollar you get 120
45:42
130 Japanese Y where do you want to buy
45:44
your
45:47
cars that's the right answer you have no
45:49
clue that doesn't tell you anything know
45:52
it tells you the the the nominal
45:54
exchanger tells you the relative value
45:55
of of currencies
45:57
but to make the decision of where you
45:59
buy your car you need to know which car
46:01
is more expensive and that's for that's
46:02
not enough to know the the the the the
46:05
the exchange the nominal exchange you
46:07
need to know what is the price of the
46:09
car in each place in its own currency
46:11
and then I'm going to use exchange rate
46:13
to translate them into some common
46:15
currency suppose I tell you now that H
46:18
the the price of of of the they do the
46:21
opposite experiment they say look the
46:23
price of a of a of a the same car in
46:26
Japan
46:27
is um
46:29
150,000
46:31
Yen well there you all have to lots of
46:33
zeros
46:35
but 150,000 Y and and in the US is500
46:40
this a used car something
46:41
$1,500 and and then I ask you a question
46:44
where do you want to buy your
46:46
car you can't answer either because you
46:49
don't know how to compare unless I give
46:51
you the nominal exchanges as well you
46:52
don't know how to compare those 150,000
46:54
yens for versus the 50 $100 so you need
46:58
both and that concept that captures both
47:01
is what is called the real exchange rate
47:03
the real exchange is design for that to
47:07
capture where you're going to do your
47:08
imports and exports okay and it's a
47:11
relative pricing of two not currencies
47:14
but
47:15
Goods okay so that's what the real
47:17
exchange is is the price of domestic
47:19
Goods relative to foreign Goods how many
47:23
japanese cars you give me for one car us
47:26
car that's a real exchange rate which is
47:28
different from the nominal exchange
47:30
rate now it's related to the nominal
47:32
exchange rate and it happens that in
47:34
practice a lot of the volatility of that
47:36
price is as result of the volatility of
47:38
the nominal exchange but this let me and
47:40
this with this I will stop so let me
47:42
call Epsilon the real exchange rate and
47:45
let me let me see how we're going to get
47:47
to that expression here so what want to
47:48
compare here is the relative value of
47:50
two goods because that's what will
47:53
matter for my my consumption decision or
47:55
my purchase decision
47:57
so suppose we're talking about this car
48:00
and suppose I know that the price of a
48:02
of of of the car in the US is
48:04
p okay and now I want to compare it with
48:07
the with well do I buy it here or do I
48:09
buy it in Japan for that um I'm going to
48:13
have to I I'm going to have to compare
48:15
them in the same currency so the first
48:18
thing I'm going to do is I'm going to
48:20
translate my US dollar price for to
48:24
Japanese dollar to to Yen pricing okay
48:27
so say the the the I'm going to have
48:30
simpler numbers than the one there
48:32
supposed to the car in the US cost
48:34
$10,000 suppose that for each dollar you
48:37
get 10 Yen then then $10,000 time 10
48:41
that means it's $ 100,000 Yen so the us
48:44
if I buy the car in the US I pay 100,000
48:46
Yen and so now ah sorry this was not
48:49
Japan in this example it's the UK well
48:51
the same story okay and it's even
48:54
simpler ER is say
48:57
then then the the car in the US cost
49:00
$10,000 and the The Exchange each dollar
49:04
buys 80 cents of 80 cents of of pounds
49:08
so that means 8,000 pound so the US car
49:12
is is cost
49:14
8,000 now I compare it with a car in the
49:16
UK say the same car and the ratio of
49:19
these two things is what we call the
49:21
real exchange rate so it's the price of
49:23
the domestic Good Times the exchange
49:25
rate divided by the foreign price and
49:28
that's a real exchange so if the if the
49:32
if the price in the of the of the car in
49:35
the UK was $9,000 and I could buy the
49:38
car in the US for $8,000 I would
49:39
probably buy it in the US in practice
49:41
there are difference between the two car
49:42
on but that tells you that's the kind of
49:44
thing that the real exchange means is a
49:46
relative price of goods okay but the way
49:48
to go from that is you have to multiply
49:51
the nominal exchange rate times the
49:52
price because that converts it into the
49:54
same currency as the price and then you
49:56
can compare them that's
49:59
idea so let let's stop here and we're
50:03
going to continue talking about open
50:05
economy next week so next on Wednesday
50:07
what I'm going to do is a review of of H
50:11
ISL MPC and and and growth
— end of transcript —
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