[00:16] so so um so remember what has been
[00:20] happening to the US economy as as as
[00:23] economy and and it happens similarly
[00:25] with a few lcks and leads and and
[00:28] differences in sizes but around the
[00:30] world in most economies around the world
[00:32] as the economy began to reopen from
[00:34] covid H we had a situation where we had
[00:38] sort of too much demand for Supply the
[00:40] the potential output using the
[00:42] terminology you'll have in the ISL NPC
[00:45] model was slow in picking up because we
[00:48] still had lots of bottlenecks in the
[00:49] supply chains and and in different
[00:52] sectors of the economy H some people
[00:55] didn't didn't want to come back to work
[00:57] to the labor force for a while and and
[01:00] and so on so so the supply side was very
[01:03] still
[01:04] impair ER not as impair as in the middle
[01:07] of the covid in 2020 say but it's still
[01:10] in pair while
[01:12] demand was very strong because people
[01:16] were fed up of being staying at home
[01:18] they had saved a lot during the the
[01:20] covid recession and they wanted to spend
[01:23] okay and there had been lots of fiscal
[01:25] support and monetary policy support and
[01:27] so on so people feel wealthy and felt
[01:29] rich
[01:30] and and so they want to spend you know
[01:33] if is there's a big demand but Supply is
[01:36] not there that is starts introducing
[01:38] inflationary pressures that's say we
[01:40] have a a negative output a positive
[01:43] output Gap output above potential output
[01:45] that puts immediately inflationary
[01:47] pressure that's what we learn from the
[01:49] Philips curve and all that
[01:51] okay and now for a while the the the FED
[01:55] um did not want to react to this because
[01:58] they thought that this was going to be
[02:00] mostly a temporary phenomenon that
[02:01] Supply would recover pretty rapidly and
[02:04] that you know people would after taking
[02:06] one trip well they wouldn't want to take
[02:08] a second one fiscal support was winding
[02:11] down and so on so they thought this
[02:12] would go away and they didn't want to
[02:14] sort of cool off the economy because
[02:16] they thought they didn't want to fight a
[02:17] temporary fight now as a result of new
[02:20] shocks the war and things like that but
[02:23] also that the initial call was not right
[02:26] was incorrect that there was a lot of
[02:28] inertia in demand and and and and that
[02:31] that pickup in demand sort of lasted a
[02:34] lot longer than I expected H is that
[02:37] that inflation really began to rise and
[02:40] the Fed was really CAU what is called
[02:43] behind the curve know they needed to
[02:45] they were they should have started at
[02:46] least Expos it's easy to see it that way
[02:49] they should have remember what you have
[02:50] if you have an a situation where output
[02:52] is above potential output the interest
[02:54] rate is supposed to be rising so the FED
[02:56] is supposed to be increasing the
[02:58] interest rate but it didn't for a while
[03:00] assuming that the forces that were
[03:02] bringing potential output down and
[03:04] demand up were so transitory when they
[03:07] discovered that wasn't the case they had
[03:09] to start catching up as a result of that
[03:11] they began to hike interest very very
[03:14] rapidly okay and the unusually rapidly
[03:17] for economy like the US and the reason
[03:20] there are many reasons why why policy
[03:23] makers especially monetary policy makers
[03:25] prefer to be gradualist meaning to move
[03:28] things in smaller steps rather than in
[03:30] one big Bank ER especially in the way up
[03:34] no if if it is to cut rates they're very
[03:36] willing to be very aggressive in cutting
[03:38] rates but racing rates is something they
[03:41] tend to be reluctant to do very very
[03:43] rapidly and one of the main reasons
[03:45] they're reluctant to do that very
[03:47] rapidly is because something may break
[03:49] in the process and there are certain
[03:51] things are very important if they break
[03:53] there are certain other things are not
[03:54] very important if they break but one of
[03:55] the things that is very important if
[03:57] they break is Banks okay and and and
[03:59] that's typically where you get run into
[04:01] trouble when there is episodes of very
[04:03] fast hikes in rates now because the US
[04:07] banking sector especially the large
[04:09] Banks were sort of very resilient they
[04:12] had lot of capital and so on there
[04:14] wasn't a lot of concern that that would
[04:16] be an issue in the US because again the
[04:17] the big Banks look very healthy uh
[04:20] deposits were flowing out of big Banks
[04:22] but it was happening all at a normal
[04:24] Pace it's normal that deposits go out of
[04:26] the banking sector when interest rates
[04:28] are to rise uh but there was no sign of
[04:31] major trouble well that changed a month
[04:33] ago as you well know and something broke
[04:35] finally no and that the major episode
[04:37] there was the Silicon Valley Bank know
[04:41] we Al saw a big bank bank run there and
[04:44] eventually that bank collapsed and since
[04:46] then things have looked a little more
[04:49] complicated so here you have for example
[04:52] a a Commercial Bank deposits as I said
[04:55] as I said as the FED began to hike so
[04:58] focus on the red line the FED began to
[05:01] hike rates then H deposits began to
[05:04] people began to move their money out of
[05:06] deposit into US treasuries money market
[05:09] funds things of that kind that was
[05:11] normal okay and that didn't lead to a
[05:14] big cut in lending which is what you
[05:15] worried about when when Banks lose
[05:17] funding but things began to change quite
[05:20] rapidly well in the second half of 2022
[05:23] this was perceived felt mostly by large
[05:26] Banks and when deposits decline
[05:28] gradually in large Banks that's not such
[05:30] a big issue because deposits are not the
[05:33] only funding source that that big banks
[05:35] have they have many other sources of
[05:37] funding H but then things that's what
[05:40] happens this year things accelerated
[05:43] very very quickly H this year and so
[05:45] this is different this is a different
[05:47] animal from this sort of very controlled
[05:49] decline in deposits as interest we're
[05:51] hiking this is a very sharp decline in
[05:54] deposits okay uh so that's a problem
[05:57] because that that's an avoid
[06:00] will hit lending okay so that's when to
[06:04] show up in terms of the moldes we have
[06:06] had if you were to use your ISL MPC
[06:09] model it would show up as an increas in
[06:11] X remember we had premium and stuff like
[06:13] that well that's a way you probably
[06:15] could model what is happening right
[06:18] now now one of the big as I said before
[06:22] these are in different Scala so a small
[06:25] Bank deposits on the left large Banks
[06:28] deposit on the on the right
[06:30] as I said before through most of of this
[06:34] episode in which deposits were declining
[06:37] in the in the banking
[06:39] sector it was mostly a phenomenon that
[06:42] was that that affected large Banks and
[06:45] it was very grad okay but what happened
[06:48] since a month ago is essentially small
[06:50] and mediumsized Banks experien a very
[06:53] large running deposits part of that went
[06:55] to money market us treasuries and and
[06:57] part of it you don't see different scale
[06:59] and
[07:00] but it went actually to large Banks it
[07:01] was relocation it's called that's called
[07:03] flight to Quality okay now even if if if
[07:08] this has been a full relocation of of H
[07:11] deposits from large bank to from small
[07:14] Banks to large Banks and so no deposit
[07:16] would have declined in the whole banking
[07:18] sector that would have consequences for
[07:20] the economy because these type of banks
[07:22] don't lend to the same type of
[07:23] people small Banks small especially
[07:26] Regional Banks lend a lot to people that
[07:31] to businesses and people that do not
[07:33] have other sources of funding they tend
[07:35] to be small businesses and so on the
[07:37] only way they can get borrow is either
[07:40] from the family or from a bank but they
[07:42] cannot issue bonds and things like that
[07:44] no and so they don't have other sources
[07:46] of
[07:48] funding and so that's the problem
[07:50] because what you see here is naturally
[07:52] when you start seeing deposits going out
[07:54] there have been also H losses
[07:57] experienced by the Banks because they
[07:59] had to recognize the losses in the asset
[08:01] side once they lost deposit is that they
[08:03] had to cut lending and you can see here
[08:05] what has been happening to lending large
[08:08] Banks they began to slow down here but
[08:10] it's a gradual slow down you have seen a
[08:12] very sharp decline in lending over the
[08:14] last three or four weeks okay so we're
[08:17] in the early phases what we like to call
[08:21] as described as a credit crunch okay and
[08:27] um now that's a the problem as I said
[08:30] before because those
[08:33] banks these Banks Banks in Gray here are
[08:36] the banks that lend primarily to small
[08:39] and medium-sized businesses okay so you
[08:42] see here the share of
[08:43] commercial H and Industrial loans by
[08:46] Bank size H and this is loans to small
[08:49] businesses loan to larger business these
[08:51] are the banks that are in grade before
[08:54] below $250 billion and you see that that
[08:57] they have a large share of loans to
[09:00] small businesses okay so those sectors
[09:03] are going to suff suffer a lot so
[09:05] there's going to be a a contraction in
[09:07] the economy and it's going to be very
[09:09] concentrated on the small businesses
[09:11] mediumsized businesses and so on and
[09:13] again it's more problematic a
[09:15] contraction in lending to those
[09:17] businesses because they don't have
[09:18] alternative sources of funding that's it
[09:21] okay it's either return earnings the
[09:24] family if it is really really small or H
[09:29] ER
[09:31] Banks again big corporations these guys
[09:34] probably have are borrowing from 10
[09:36] different banks and and and they have
[09:38] issued corporate bonds and and they even
[09:41] have commercial paper this a entirely
[09:44] different life when you live here than
[09:45] when you live
[09:47] here H if you look by sectors that also
[09:50] is going to have implications for
[09:52] sectors so this is going to be clearly
[09:54] contractionary but it's not going to be
[09:56] equally contractionary it will depend on
[09:58] 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