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