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today we're going to talk about um

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perhaps the most important model in this

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class the ISL MPC model which puts

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together all that we have done up to now

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but before we do that uh let's talk a

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little bit about the current

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events uh who knows what that

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is is this a exam week or

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what Silicon Valley Bank exactly no so

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Silicon Valley Bank the 16th Bank in

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size asset size in the US ER went

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essentially under last Friday was shut

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down by the FD last last

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Friday so that's the decline in in the

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stock value uh during Thursday Friday

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and uh and then it was shut down and you

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see that it's not being traded anymore

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um so that's a pretty significant event

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and the the weekend was pretty stressful

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for anyone involved in in in this event

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the treasury the FDIC the Federal

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Reserve and so on um

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it's first it was a large I mean it's

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not one of the big systemic Banks if you

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will it's not JP Morgan City Bank of

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America one of those Banks which are

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regulated even differently from these

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Banks but still is a pretty large Bank

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you see by asset size $29

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billion H which is you know comparable

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to Washington Mutual which was the

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largest bank that went under during the

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global financial crisis Great Recession

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at that time there were lots of other

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banks that went under H but the largest

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was comparable to this one and in fact

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all the things that were done over the

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weekend and that still being done today

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is to prevent something like this

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happening here as well okay and so it

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was

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a a pretty significant event now what

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happened to Silicon Valley

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Bank um well in the the immediate cause

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of of of of the failure is what always

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kills a bank which is a r

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by this depositors okay and what you see

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here is is the following this is this

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this Bank actually grew enormously over

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the last two three years essentially

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doubl its asset size

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um but it began to have sort of outflow

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net outflows of

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deposits during 2022 and the reason for

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that is not because the business was

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doing poorly anything it was simply

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because this is a bank that service

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primarily of the high the tech sector

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startups companies and things like that

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and those sectors were having hard time

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raising new capital in an environment

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that was not very friendly towards the

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tech sector so so so they began to

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withdraw on their deposits and and

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that's what led to these flows here now

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eventually

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ER because of this and and something

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I'll explain in a few minutes ER

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this the they decided svb Bank decided

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to issue new Equity ER issue new

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Equity to cover certain losses they had

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incurrent and today in the mod of social

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in the world of social media that

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immediately led to sort of massive

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spread that this bank was in trouble and

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then you saw enormous attempts to

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withdraw deposits now not all of these

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these were fulfilled but there was a

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massive pressure to withdraw deposits

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and and and and that's the end always

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for a bank that doesn't find an

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alternative source of funding and often

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for withdrawals of that size the only

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alternative source of funding is either

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that some other bank buys you or that

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the FED comes in and gives you a

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line anyway so what is the that was

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immediate and it's always whenever you

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ask you hear about the bank run the

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immediate cost of the problem is a run

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from of the depositors from deposits in

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that that bank now why did this happen

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in this in this particular bank again I

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explain why is that you saw those small

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withdrawals of deposits but but what

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happens to this to them is actually

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there as I said before their deposits

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grew very rapidly over the last two

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three years and then rather than being

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very risky lenders rather than investing

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you know sometimes when Banks grow very

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rapidly they do lots of crazy things you

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know they in they make lots of loans

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without going doing the D diligent

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process and all that that's not what

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they did they bought treasury bonds the

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safest as as you can imagine they bought

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10 year treasury bonds lots of them but

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they bought them at the wrong time they

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bought them right before the hike in

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interest rates that we began to see in

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2022 and we already looked at the

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relation between interest rates and

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price of bonds well you have a 10-year

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bond and the interest starts going up

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the price of that Bond starts

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declining now that is not is problematic

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for a bank but not entirely the end of

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the story because that means that the

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the the market value of the bonds you're

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holding among your assets starts

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declining but Banks do not need to

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recognize that

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loss unless they sell the

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bonds because the the the logic is that

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well if the guy just sits on the bond

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the bond hasn't really lost any value in

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the sense that it will get the same

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coupons that he was planning to get and

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so on this is us treasuries us

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treasuries are not going to default in

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the coupons let's hope it's not going to

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happen in a few months from now but but

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typically they don't default on coupons

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so so the logic the regul regulation is

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assigned in such a way perhaps is a

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failure I think there is a problem there

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but that they don't need to

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recognize the losses unless they sell

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the bonds so they look pretty healthy

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because they had massive amount of

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Treasury bonds they did not need to

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recognize that

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problem is that when this small W

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relatively small withdrawals start at

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some point they needed to find a

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substitute for those funds they need to

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honor the deposits that that were being

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withdrawn and at that point they had to

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sell assets and when they sold assets

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they made the loss because at that point

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you have to recognize the loss because

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you're not going to hold the the bond

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until expiration and clip all the

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coupons that come from it so you have to

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recognize the loss that's a loss

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that led the CEO to announce that they

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needed a fundraising to cover a $2.5

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billion hold they had as a result of the

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losses okay now okay so now we have a we

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know why where the losses came from now

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if you notice the losses are not that

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big I mean this is a bank with $200

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billion and and the losses were

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relatively small where is the other leg

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of the problem it's

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here you know in in the US deposits are

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ured up to

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$250,000 that means no matter what

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happens to the bank where you have the

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money if that bank goes under and you

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have deposits for below $250,000 the

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FDIC comes and gives you a check okay so

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there's no risk so if you have deposit

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under $250,000 you don't need to worry

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about this you may go you don't need to

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read the news about this bank

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because you will get your funds in fact

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when when the bank was shut down on

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Friday the FDIC announc immediately

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every depositor under $250,000 can come

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on Monday and get his money okay so

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there's no issue there and most banks

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have a large share of depositors that

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are small depositor that means they are

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covered by this Deposit Insurance

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mechanism which was designed precisely

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to prevent runs because if you don't

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need to worry about where you get your

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money know you don't need to run on the

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bank the problem is that this bank was

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very different in the composition of

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depositors he had primarily business

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deposits meaning it was all these

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startup companies and so on in the tech

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sector they had their their deposits

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there and those deposits were much

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larger than

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$250,000 if you

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see it's about I think it's close to 95%

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of the deposits were not covered by the

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insurance by the fdac insurance okay

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that means it's a very different

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calculation when you have a deposit

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that's not covered by insurance and then

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you start feeling that the bank Mak may

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go under what do you do you take your

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money out you know put it some you send

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it to JP Morgan where there's no risk

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and wait until this thing is

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resolved now in this case and that's

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what typically happens in this case it

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happens even faster than normally why

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because many of the depositors the

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business that were deposited in there

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were were a startups that were being

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seeded by some Venture Capital

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funds and Venture Capital funds as soon

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as they noticed that there was a problem

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here began to call all the startups and

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tell him hey take that money out of

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there because you know they may run into

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travel so it was a venture capital world

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that caused the Run

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effectively and and and and and that's

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what happened

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okay now so that's that's what happened

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that's the reason for the run and and

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and

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the and so there was a a problem the

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problem was not that big but but the

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problem is that the deposits were very

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un safe they were not covered and moving

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deposits out is very easy I mean you

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just you know you just wire your money

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to another bank so so so why wait there

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why risk it and that's that's what

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happened it's called in economics

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coordination failure when I mean if

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everyone freezes and say okay nobody

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takes the money out and so on this stuff

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is when I pass then we're safe but but

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but since we don't call each other and

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we don't trust each other to really

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leave the money there we we we we make

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the call only after we have taken our

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money out and since we all think the

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same way then you get a run on the bank

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now let me start connecting this a

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little bit with uh with the kind of

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things we have done in in this course I

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I I I may actually discuss runs later in

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the course as a as a as a topic crisis

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speculative attacks and things like that

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but for

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now here what you have is an indicator

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of essentially is this is the vix a is a

258
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is an indicator of Supply volatility

259
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something is extracted from the price of

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options you don't need to know the

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details but the point is that that is

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one of the main indicators of of fear of

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of how afraid are investors in a moment

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in the market and and uh and what you

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can see here is that that this indicator

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the vixs essentially

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Spike

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Thursday and and Thursday and Friday

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went up Friday went up very very rapidly

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and then it got stabilized a little

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now ER it turned out that it turns out

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that over the weekend ER H you may have

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heard the government the Consolidated

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Government came up with a very massive

275
00:11:43,559 --> 00:11:49,479
package to to prevent runs on the

276
00:11:46,559 --> 00:11:51,518
remaining Banks and and also to prevent

277
00:11:49,480 --> 00:11:53,920
the fact that I mean all of these were

278
00:11:51,519 --> 00:11:57,078
business deposits of a small companies

279
00:11:53,919 --> 00:11:59,958
that used even this bank for the payroll

280
00:11:57,078 --> 00:12:01,879
and so on so so what was done of this

281
00:11:59,958 --> 00:12:03,199
weakness that all the deposit not only

282
00:12:01,879 --> 00:12:06,799
the ones under

283
00:12:03,200 --> 00:12:08,600
$250,000 were guarantee by the FDIC

284
00:12:06,799 --> 00:12:11,399
there are mechanism under which you can

285
00:12:08,600 --> 00:12:15,159
activate that so that means now all the

286
00:12:11,399 --> 00:12:15,159
depositors were made

287
00:12:15,399 --> 00:12:20,958
whole and but the idea was not it was

288
00:12:18,919 --> 00:12:23,799
part partly the reason to do that it was

289
00:12:20,958 --> 00:12:25,919
to prevent a mess in the pay roles of

290
00:12:23,799 --> 00:12:28,039
the small companies and all that that

291
00:12:25,919 --> 00:12:31,159
had their account in in in this bank but

292
00:12:28,039 --> 00:12:35,480
it was also to prevent on other Banks

293
00:12:31,159 --> 00:12:38,480
you know and uh and so on top of this

294
00:12:35,480 --> 00:12:42,440
the FED now has a line of

295
00:12:38,480 --> 00:12:44,480
credit ER for banks to not have to sell

296
00:12:42,440 --> 00:12:46,839
their assets for small Banks they can

297
00:12:44,480 --> 00:12:48,519
just pledge the assets to the central

298
00:12:46,839 --> 00:12:52,399
bank and get an exchange for that the

299
00:12:48,519 --> 00:12:54,320
cash they need okay and they can do that

300
00:12:52,399 --> 00:12:56,879
without recognizing the implicit loss so

301
00:12:54,320 --> 00:12:59,839
without marking to market the price of

302
00:12:56,879 --> 00:13:03,120
the bonds okay so how this mechanism

303
00:12:59,839 --> 00:13:05,440
existed before the pl of

304
00:13:03,120 --> 00:13:06,720
svb we would not have seen anything like

305
00:13:05,440 --> 00:13:09,079
that but the whole idea was to prevent

306
00:13:06,720 --> 00:13:11,879
that other Banks run into into that kind

307
00:13:09,078 --> 00:13:14,000
of trouble now the markets reacted well

308
00:13:11,879 --> 00:13:15,759
to all that overnight and so on but the

309
00:13:14,000 --> 00:13:17,759
vi kept going up this morning now it's

310
00:13:15,759 --> 00:13:19,439
coming down again I mean there's still a

311
00:13:17,759 --> 00:13:21,319
lot of stress and if you see the shares

312
00:13:19,440 --> 00:13:23,600
of First Republic Bank for example had

313
00:13:21,320 --> 00:13:26,000
declined by 60% today and things like

314
00:13:23,600 --> 00:13:30,120
that so so there's a still Panic going

315
00:13:26,000 --> 00:13:32,958
on okay and as a result of that ER all

316
00:13:30,120 --> 00:13:35,120
these indicators of stress sort of are

317
00:13:32,958 --> 00:13:37,799
very stressed out remember credit

318
00:13:35,120 --> 00:13:39,560
spreads I told you about that X that we

319
00:13:37,799 --> 00:13:41,000
had Le several lectures ago the

320
00:13:39,559 --> 00:13:42,679
probability of the fault of a bone the

321
00:13:41,000 --> 00:13:44,839
perceived probability of the fault all

322
00:13:42,679 --> 00:13:47,319
those things went up a lot I mean the

323
00:13:44,839 --> 00:13:49,240
Riser the bonds the closer you are to

324
00:13:47,320 --> 00:13:51,160
the financial system particular to small

325
00:13:49,240 --> 00:13:53,399
Banks the larger those spreads have

326
00:13:51,159 --> 00:13:57,240
become so X went up a

327
00:13:53,399 --> 00:13:58,879
lot this picture that comes next I find

328
00:13:57,240 --> 00:14:00,320
it very interesting from the point of

329
00:13:58,879 --> 00:14:03,439
view of this

330
00:14:00,320 --> 00:14:06,199
course what this is is the following

331
00:14:03,440 --> 00:14:11,079
this is the market

332
00:14:06,198 --> 00:14:14,359
expectation of the next hike by the

333
00:14:11,078 --> 00:14:18,278
fed the FED next announcement on policy

334
00:14:14,360 --> 00:14:20,399
rate happens on the 22nd March 22nd so

335
00:14:18,278 --> 00:14:23,159
remember what has been happening is that

336
00:14:20,399 --> 00:14:24,919
that that ER since the US has been

337
00:14:23,159 --> 00:14:26,958
running sort of very hot with lots of

338
00:14:24,919 --> 00:14:29,599
inflation interest rate were increased

339
00:14:26,958 --> 00:14:31,919
very rapidly at clips of 50 basis points

340
00:14:29,600 --> 00:14:33,920
a CLI that's very large changes in

341
00:14:31,919 --> 00:14:38,278
policy rate for a country as large as

342
00:14:33,919 --> 00:14:40,078
the US and and so we had this big 25

343
00:14:38,278 --> 00:14:42,078
basis points increases and a few

344
00:14:40,078 --> 00:14:45,120
meetings ago they decided to lower the

345
00:14:42,078 --> 00:14:46,958
pace of the increases to 25 basis points

346
00:14:45,120 --> 00:14:48,320
rather than 50 Bas points per meeting

347
00:14:46,958 --> 00:14:50,000
okay so they said we're going to keep

348
00:14:48,320 --> 00:14:53,560
raising interest rate but we're going to

349
00:14:50,000 --> 00:14:56,559
go out to 25 basis points now it turns

350
00:14:53,559 --> 00:14:58,278
out so this is 25 basis points the data

351
00:14:56,559 --> 00:14:59,879
has becoming very hot remember we said

352
00:14:58,278 --> 00:15:01,320
inflation looked to have Peak and now

353
00:14:59,879 --> 00:15:03,919
it's beginning sort of to turn around

354
00:15:01,320 --> 00:15:05,839
again it's beginning to rise so what has

355
00:15:03,919 --> 00:15:09,399
been happening is that the market say

356
00:15:05,839 --> 00:15:12,519
Okay 25% basis point is the most likely

357
00:15:09,399 --> 00:15:14,360
next hike but you see the expectation of

358
00:15:12,519 --> 00:15:16,560
that is it was sort of a steady around

359
00:15:14,360 --> 00:15:19,000
30 basis points some people expected

360
00:15:16,559 --> 00:15:21,319
some major players expected the FED to

361
00:15:19,000 --> 00:15:25,078
hike by 50 basis points not 25 basis

362
00:15:21,320 --> 00:15:27,040
points by early last week data came very

363
00:15:25,078 --> 00:15:28,758
hot so there was indication that clearly

364
00:15:27,039 --> 00:15:30,958
inflation was picking up again the labor

365
00:15:28,759 --> 00:15:32,360
market Market was very strong and so on

366
00:15:30,958 --> 00:15:34,518
so look what happened to the bets

367
00:15:32,360 --> 00:15:37,560
immediately expected value went up this

368
00:15:34,519 --> 00:15:39,360
is all traded it went up and and the

369
00:15:37,559 --> 00:15:42,439
expectation was for the next meeting was

370
00:15:39,360 --> 00:15:44,800
up north of of 40 basis points so

371
00:15:42,440 --> 00:15:47,319
essentially most of the market thought

372
00:15:44,799 --> 00:15:49,039
that the next hike would be 50 basis

373
00:15:47,318 --> 00:15:51,278
points

374
00:15:49,039 --> 00:15:54,078
okay but look what happened and then the

375
00:15:51,278 --> 00:15:58,519
problems of this with this Bank began

376
00:15:54,078 --> 00:16:00,439
and look how this pleted today is 15

377
00:15:58,519 --> 00:16:02,278
basis point is expected value that means

378
00:16:00,440 --> 00:16:04,839
very few people are expecting 50 basis

379
00:16:02,278 --> 00:16:07,559
point A lot of people are thinking 25

380
00:16:04,839 --> 00:16:11,720
still but about an equal size expecting

381
00:16:07,559 --> 00:16:14,439
zero so a POS in the interest rate hike

382
00:16:11,720 --> 00:16:17,079
by the FED okay and all that is a result

383
00:16:14,440 --> 00:16:18,959
of the events of the last two three

384
00:16:17,078 --> 00:16:21,198
days

385
00:16:18,958 --> 00:16:24,239
Y what is there to learn from this I

386
00:16:21,198 --> 00:16:27,159
guess in like the bigger structure or

387
00:16:24,240 --> 00:16:29,000
who's at fault is it the people who got

388
00:16:27,159 --> 00:16:31,399
really scared all these depositors that

389
00:16:29,000 --> 00:16:34,078
got potentially scared or or fearmonger

390
00:16:31,399 --> 00:16:36,240
in that capacity is it that the banks

391
00:16:34,078 --> 00:16:37,879
don't necessarily have I mean I can't

392
00:16:36,240 --> 00:16:39,240
feel like it's an unre there are many

393
00:16:37,879 --> 00:16:40,958
good questions and and and you're going

394
00:16:39,240 --> 00:16:42,198
to see a lot of that and politicians are

395
00:16:40,958 --> 00:16:44,679
going to talk a lot about that in the

396
00:16:42,198 --> 00:16:46,318
next few days and so on it's very clear

397
00:16:44,679 --> 00:16:49,159
that there was some sort of regulatory

398
00:16:46,318 --> 00:16:51,000
failure here the regulator it was pretty

399
00:16:49,159 --> 00:16:53,399
obvious that I mean this this bank had

400
00:16:51,000 --> 00:16:56,000
doubled the asset size in in in a year

401
00:16:53,399 --> 00:16:58,879
that's already a red flag and and these

402
00:16:56,000 --> 00:17:00,879
guys are regulated by the Fed so the the

403
00:16:58,879 --> 00:17:05,119
s Francisco fed should have been worried

404
00:17:00,879 --> 00:17:07,038
about this Bank ER there is issues

405
00:17:05,119 --> 00:17:08,719
conventional issues of diversification I

406
00:17:07,038 --> 00:17:11,720
mean it's pretty crazy to have all your

407
00:17:08,720 --> 00:17:12,919
savings in One Bank especially if you're

408
00:17:11,720 --> 00:17:16,000
not

409
00:17:12,919 --> 00:17:18,919
insure there is issues there's

410
00:17:16,000 --> 00:17:23,279
also remember after the global financial

411
00:17:18,919 --> 00:17:26,319
crisis there's there was a bill designed

412
00:17:23,279 --> 00:17:27,639
to legislation designed to strengthen

413
00:17:26,318 --> 00:17:30,119
the balance sheet of the banks it made

414
00:17:27,640 --> 00:17:31,759
them hold a lot more cas Capital they

415
00:17:30,119 --> 00:17:33,439
are subject see if they're systemic they

416
00:17:31,759 --> 00:17:35,200
are consider they're subject to stress

417
00:17:33,440 --> 00:17:36,679
test where sort of regulators go in

418
00:17:35,200 --> 00:17:40,558
there and check whether portfolios can

419
00:17:36,679 --> 00:17:42,160
survive major micros shcks and so on H

420
00:17:40,558 --> 00:17:45,558
and that's that's called The Dot Frank

421
00:17:42,160 --> 00:17:48,840
Bill okay so that was done in

422
00:17:45,558 --> 00:17:50,639
2018 that got partially undone and

423
00:17:48,839 --> 00:17:52,000
partially andone precisely for these

424
00:17:50,640 --> 00:17:54,919
type of Banks and these guys were

425
00:17:52,000 --> 00:17:56,880
actually loving for that they said okay

426
00:17:54,919 --> 00:17:58,520
why don't you because to be sort of

427
00:17:56,880 --> 00:18:00,039
really stress test and so on by the

428
00:17:58,519 --> 00:18:03,279
regular you have to be big enough to

429
00:18:00,038 --> 00:18:06,359
really be able to live a a big mess and

430
00:18:03,279 --> 00:18:10,158
and and and so what these guys and and

431
00:18:06,359 --> 00:18:13,319
Banks like them did is they Lobby a lot

432
00:18:10,159 --> 00:18:15,000
so they got the the the threshold of

433
00:18:13,319 --> 00:18:18,720
asset that you need to have in order to

434
00:18:15,000 --> 00:18:21,200
be stress stress tested and so on raise

435
00:18:18,720 --> 00:18:24,000
dramatically so they were right below

436
00:18:21,200 --> 00:18:27,558
the level that you need to be really

437
00:18:24,000 --> 00:18:29,480
sort of monitored very very closely by

438
00:18:27,558 --> 00:18:31,759
the regulator by the by the FED if

439
00:18:29,480 --> 00:18:33,640
you're a systemic bank then the FED

440
00:18:31,759 --> 00:18:35,279
regulates you these guys were lightly

441
00:18:33,640 --> 00:18:37,960
regulated by the FED because they were

442
00:18:35,279 --> 00:18:40,558
below that threshold so there regulatory

443
00:18:37,960 --> 00:18:44,079
failures it's clear that the regulator

444
00:18:40,558 --> 00:18:48,359
fail what it did

445
00:18:44,079 --> 00:18:50,319
depositors didn't diversify enough ER

446
00:18:48,359 --> 00:18:52,158
they didn't diversify enough the bank

447
00:18:50,319 --> 00:18:54,200
itself didn't diversify enough the the

448
00:18:52,159 --> 00:18:55,480
source of funding I mean what is very

449
00:18:54,200 --> 00:18:56,720
special of this bank and that's what

450
00:18:55,480 --> 00:18:59,440
gives us hope that this stuff is not

451
00:18:56,720 --> 00:19:01,640
going to spread all around is that their

452
00:18:59,440 --> 00:19:04,600
funding was very sort of you know was

453
00:19:01,640 --> 00:19:07,200
all coming from the same sector large

454
00:19:04,599 --> 00:19:08,558
saver large depositors and so on the

455
00:19:07,200 --> 00:19:10,759
typical bank doesn't have that they have

456
00:19:08,558 --> 00:19:12,240
a much broader source of funding which

457
00:19:10,759 --> 00:19:13,960
is what you need because you know

458
00:19:12,240 --> 00:19:16,839
otherwise so so there are lots of

459
00:19:13,960 --> 00:19:19,759
lessons for Bankers for

460
00:19:16,839 --> 00:19:22,038
Regulators ER for microeconomist as well

461
00:19:19,759 --> 00:19:24,640
I mean to tell you the truth one of the

462
00:19:22,038 --> 00:19:26,919
concerns with with the pace at which the

463
00:19:24,640 --> 00:19:28,840
FED has been hik in interest rates is

464
00:19:26,919 --> 00:19:30,440
that people were wondering well do we we

465
00:19:28,839 --> 00:19:32,158
know whe something will break at some

466
00:19:30,440 --> 00:19:33,200
point and there was a lot of concern

467
00:19:32,159 --> 00:19:36,720
that something could break well

468
00:19:33,200 --> 00:19:39,679
something broke now and this broke

469
00:19:36,720 --> 00:19:41,440
entirely the part of the the loss comes

470
00:19:39,679 --> 00:19:43,559
entirely from interest rate highs

471
00:19:41,440 --> 00:19:45,960
essentially they got into a portfolio of

472
00:19:43,558 --> 00:19:48,359
long that was very long rat when rates

473
00:19:45,960 --> 00:19:51,240
began to rise so they they had losses

474
00:19:48,359 --> 00:19:54,359
entirely from that and that's a risk I

475
00:19:51,240 --> 00:19:56,720
mean when you do monetary policy is that

476
00:19:54,359 --> 00:19:58,959
some people will be stretch out there

477
00:19:56,720 --> 00:20:00,880
and and and if you sort of sometimes

478
00:19:58,960 --> 00:20:02,400
miss one that is important that that's

479
00:20:00,880 --> 00:20:06,240
very costly and I think was that's one

480
00:20:02,400 --> 00:20:08,600
of the reasons they wanted to lower the

481
00:20:06,240 --> 00:20:11,240
the interest R hikes from 50 basis

482
00:20:08,599 --> 00:20:14,480
points to 25 basis points because they

483
00:20:11,240 --> 00:20:17,480
knew that something could be fragile out

484
00:20:14,480 --> 00:20:20,400
there and and and this was one of those

485
00:20:17,480 --> 00:20:23,558
things so those are those are

486
00:20:20,400 --> 00:20:25,960
lessons now I was about to connect with

487
00:20:23,558 --> 00:20:28,798
the things we did in a few lectures ago

488
00:20:25,960 --> 00:20:31,679
I said look so this is telling you the

489
00:20:28,798 --> 00:20:34,960
markets when they saw this x going

490
00:20:31,679 --> 00:20:37,000
up and started betting that the that the

491
00:20:34,960 --> 00:20:38,759
FED will not hike interest rate as much

492
00:20:37,000 --> 00:20:40,000
and in fact that they may even pause

493
00:20:38,759 --> 00:20:42,200
rather than raise the interest rate as

494
00:20:40,000 --> 00:20:45,798
was planned they may even pause interest

495
00:20:42,200 --> 00:20:45,798
rates we talked about

496
00:20:45,839 --> 00:20:51,959
this lecture

497
00:20:48,679 --> 00:20:56,200
seven remember in lecture seven when we

498
00:20:51,960 --> 00:20:59,200
talk about the expanded islm model we

499
00:20:56,200 --> 00:21:01,640
had this x variable and we said look if

500
00:20:59,200 --> 00:21:03,159
x goes up that measure of riskiness and

501
00:21:01,640 --> 00:21:06,240
so on that increases the cost of

502
00:21:03,159 --> 00:21:08,480
borrowing for the private sector that is

503
00:21:06,240 --> 00:21:11,120
like a shift in the yes to the left for

504
00:21:08,480 --> 00:21:13,798
any given safe interest rate saved by

505
00:21:11,119 --> 00:21:15,479
the central bank now all of the sudden

506
00:21:13,798 --> 00:21:18,960
the cost of borrowing for companies is

507
00:21:15,480 --> 00:21:22,798
higher and therefore this is

508
00:21:18,960 --> 00:21:24,519
contractionary okay and then we went on

509
00:21:22,798 --> 00:21:26,079
remember we went on and said well here

510
00:21:24,519 --> 00:21:29,079
it is the question what should the

511
00:21:26,079 --> 00:21:32,000
Central Bank do in this case

512
00:21:29,079 --> 00:21:32,000
in which X went

513
00:21:33,000 --> 00:21:37,679
up that's was the next slide inide of

514
00:21:35,679 --> 00:21:39,798
fact you know lower the interest rate

515
00:21:37,679 --> 00:21:44,000
because there's one component of cost of

516
00:21:39,798 --> 00:21:47,119
borrowing that's going up for for ER for

517
00:21:44,000 --> 00:21:49,159
firms which is the X well the FED can

518
00:21:47,119 --> 00:21:51,199
offset that by lowering the interest

519
00:21:49,159 --> 00:21:52,559
rate now here they're not planning yet

520
00:21:51,200 --> 00:21:54,000
to lower the interest rate they were

521
00:21:52,558 --> 00:21:56,200
planning to raise interest and now

522
00:21:54,000 --> 00:21:58,640
they're slowing down that that's a bet

523
00:21:56,200 --> 00:22:01,120
so the market knows some basic and

524
00:21:58,640 --> 00:22:03,600
expanded islm model because that's

525
00:22:01,119 --> 00:22:05,798
that's what you know explains exactly

526
00:22:03,599 --> 00:22:08,519
what you should anticipate that that's

527
00:22:05,798 --> 00:22:10,720
what is likely to to

528
00:22:08,519 --> 00:22:12,918
happen anyways that's where we are at

529
00:22:10,720 --> 00:22:12,919
this

530
00:22:13,480 --> 00:22:17,319
moment any questions about this

531
00:22:15,440 --> 00:22:19,919
otherwise I'm going to move to the

532
00:22:17,319 --> 00:22:22,038
lecture really but I thought we had to

533
00:22:19,919 --> 00:22:25,159
talk about

534
00:22:22,038 --> 00:22:27,440
it well in anyways if it gets a lot

535
00:22:25,159 --> 00:22:29,200
Messier I'm hoping that it won but if it

536
00:22:27,440 --> 00:22:31,200
gets a lot Messier then we can another

537
00:22:29,200 --> 00:22:33,919
section at the end I can replace

538
00:22:31,200 --> 00:22:37,440
something for for something on banking

539
00:22:33,919 --> 00:22:37,440
crisis and something like that

540
00:22:38,200 --> 00:22:45,360
okay which is what I teach in one of my

541
00:22:40,599 --> 00:22:48,158
graduate courses so would be would be

542
00:22:45,359 --> 00:22:52,199
fine anyway so now what I want to do is

543
00:22:48,159 --> 00:22:53,919
start this islm PC model and sort of the

544
00:22:52,200 --> 00:22:55,600
number the name is not very creative

545
00:22:53,919 --> 00:22:59,759
it's pretty obvious what we're going to

546
00:22:55,599 --> 00:23:02,319
do here no is going to combine the aslm

547
00:22:59,759 --> 00:23:04,640
with with the Philips curve and what

548
00:23:02,319 --> 00:23:07,119
this this will do for us is it will

549
00:23:04,640 --> 00:23:09,440
allow us to think not only about the

550
00:23:07,119 --> 00:23:11,239
impact of a policy or a shock but also

551
00:23:09,440 --> 00:23:14,519
think about what happens over time with

552
00:23:11,240 --> 00:23:16,798
that shock okay ER not to the long run

553
00:23:14,519 --> 00:23:18,879
but we call this analysis sort of the

554
00:23:16,798 --> 00:23:21,359
short run which is what happens in the

555
00:23:18,880 --> 00:23:24,200
very few early weeks months and what

556
00:23:21,359 --> 00:23:26,079
happens in the medium run say a year a

557
00:23:24,200 --> 00:23:30,440
year and a half from now and so this

558
00:23:26,079 --> 00:23:30,439
model will allow us to put all of the

559
00:23:30,679 --> 00:23:36,480
together

560
00:23:32,200 --> 00:23:39,319
um so and But but so so so you don't get

561
00:23:36,480 --> 00:23:40,798
lost on this so the analysis of the

562
00:23:39,319 --> 00:23:44,158
short run essentially will remain

563
00:23:40,798 --> 00:23:47,200
unchanged it's is our islm mod it's just

564
00:23:44,159 --> 00:23:50,039
that give it a little time and you start

565
00:23:47,200 --> 00:23:51,840
seeing other certain effects get undone

566
00:23:50,038 --> 00:23:54,440
and some others get exacerbated and so

567
00:23:51,839 --> 00:23:56,918
on okay but but the short one is still

568
00:23:54,440 --> 00:23:59,159
islm is your basic mod but then we're

569
00:23:56,919 --> 00:24:03,360
going to see that things happen

570
00:23:59,159 --> 00:24:05,200
over time so remember the slm model was

571
00:24:03,359 --> 00:24:07,759
essentially this is equilibrium in the

572
00:24:05,200 --> 00:24:12,080
Goods Market and then we had an LM which

573
00:24:07,759 --> 00:24:14,919
said I equal to I bar no and so I'm

574
00:24:12,079 --> 00:24:17,439
going to replace the LM already inside

575
00:24:14,919 --> 00:24:20,120
this and I get my islm mod so for any

576
00:24:17,440 --> 00:24:22,519
given I bar I could solve out for

577
00:24:20,119 --> 00:24:25,119
equilibrium output

578
00:24:22,519 --> 00:24:27,200
now here I'm going to do I'm going to

579
00:24:25,119 --> 00:24:28,639
adopt the the the I didn't want to do it

580
00:24:27,200 --> 00:24:30,880
before but I think at this point is

581
00:24:28,640 --> 00:24:33,679
useful because of will simplify the

582
00:24:30,880 --> 00:24:35,559
diagrams when we draw them to really

583
00:24:33,679 --> 00:24:38,440
think of the FED as setting the real

584
00:24:35,558 --> 00:24:40,440
interest rate okay so I'm going to

585
00:24:38,440 --> 00:24:41,640
assume now and then I'm going to explain

586
00:24:40,440 --> 00:24:45,200
what

587
00:24:41,640 --> 00:24:46,759
happens when that's a bad assumption but

588
00:24:45,200 --> 00:24:48,440
but I'm going to assume for now that

589
00:24:46,759 --> 00:24:50,319
rather than the FED setting the nominal

590
00:24:48,440 --> 00:24:54,200
interest rate that the FED is set in the

591
00:24:50,319 --> 00:24:57,398
real interest rate okay so it's setting

592
00:24:54,200 --> 00:24:59,759
this and then we're going to talk about

593
00:24:57,398 --> 00:25:01,918
problems I mean in

594
00:24:59,759 --> 00:25:03,839
principle if the interest rate is not

595
00:25:01,919 --> 00:25:06,360
against the zero lower

596
00:25:03,839 --> 00:25:07,839
bound the FED can always do that say

597
00:25:06,359 --> 00:25:09,119
okay I'm going to give them them I'm

598
00:25:07,839 --> 00:25:10,839
going to give you the nominal interest

599
00:25:09,119 --> 00:25:12,959
rate that given this expected inflation

600
00:25:10,839 --> 00:25:14,558
gives me the real interest rate I want

601
00:25:12,960 --> 00:25:16,600
okay that's what the FED is really

602
00:25:14,558 --> 00:25:18,158
trying to do all the time the FED is not

603
00:25:16,599 --> 00:25:19,959
trying to figure out what is the

604
00:25:18,159 --> 00:25:21,799
equilibrium nominal interest rate he's

605
00:25:19,960 --> 00:25:23,480
always trying to figure out whether the

606
00:25:21,798 --> 00:25:26,038
real interest rate is at the right level

607
00:25:23,480 --> 00:25:27,880
or not for the economy now the tool they

608
00:25:26,038 --> 00:25:29,079
have is a nominal interest rate but they

609
00:25:27,880 --> 00:25:32,600
are thinking thinking always about the

610
00:25:29,079 --> 00:25:35,000
real interest rate and and and and

611
00:25:32,599 --> 00:25:37,278
sometimes there's a problem because it's

612
00:25:35,000 --> 00:25:38,759
a when you against a zero lower bound

613
00:25:37,278 --> 00:25:41,159
then you can't affect the real interest

614
00:25:38,759 --> 00:25:43,519
in the same way but but most of the time

615
00:25:41,159 --> 00:25:46,000
you can and so I'm going to think I'm

616
00:25:43,519 --> 00:25:49,200
going to rewrite the slm mo now but I'm

617
00:25:46,000 --> 00:25:50,880
going to call this our bar and the bar

618
00:25:49,200 --> 00:25:52,519
is there just to tell you remind you

619
00:25:50,880 --> 00:25:54,600
that there something that the FED is

620
00:25:52,519 --> 00:25:57,398
setting

621
00:25:54,599 --> 00:25:59,319
okay so that's our aslm remember the

622
00:25:57,398 --> 00:26:01,119
Philips curve part

623
00:25:59,319 --> 00:26:03,200
the Philips that was our Philips curve

624
00:26:01,119 --> 00:26:05,398
remember the last once we replace the

625
00:26:03,200 --> 00:26:07,640
natural rate of unemployment in there we

626
00:26:05,398 --> 00:26:09,319
had the inflation minus expected

627
00:26:07,640 --> 00:26:11,240
inflation was a decreasing function of

628
00:26:09,319 --> 00:26:12,798
the unemployment Gap okay so if

629
00:26:11,240 --> 00:26:15,359
unemployment was above the natural rate

630
00:26:12,798 --> 00:26:18,000
of unemployment inflation was lower than

631
00:26:15,359 --> 00:26:19,599
expected inflation and conversely if the

632
00:26:18,000 --> 00:26:21,398
unemployment rate was lower than the

633
00:26:19,599 --> 00:26:23,759
unemployment rate and I said one the

634
00:26:21,398 --> 00:26:27,359
situation of the US today is that

635
00:26:23,759 --> 00:26:29,879
everything seems to point towards toward

636
00:26:27,359 --> 00:26:31,079
a situation where U is below un that's

637
00:26:29,880 --> 00:26:34,278
the reason we're seeing sort of high

638
00:26:31,079 --> 00:26:35,558
inflation okay now what I'm going to do

639
00:26:34,278 --> 00:26:37,839
next is I'm going to go from an

640
00:26:35,558 --> 00:26:40,079
employment to Output so I can put you

641
00:26:37,839 --> 00:26:43,480
see I don't have an employment anywhere

642
00:26:40,079 --> 00:26:46,158
here I have output so what I want to do

643
00:26:43,480 --> 00:26:48,480
is play with the Philips curve and until

644
00:26:46,159 --> 00:26:50,440
I write it in the space of inflation and

645
00:26:48,480 --> 00:26:52,079
output not inflation and unemployment so

646
00:26:50,440 --> 00:26:55,720
I can put the two curves together that's

647
00:26:52,079 --> 00:26:57,720
what I want to remember I want to merge

648
00:26:55,720 --> 00:26:59,399
here the slm with the PC so I want to

649
00:26:57,720 --> 00:27:03,120
put them in the the same

650
00:26:59,398 --> 00:27:04,678
variable so remember we have operated

651
00:27:03,119 --> 00:27:07,719
with a very simple production function

652
00:27:04,679 --> 00:27:09,679
in which output is equal to employment

653
00:27:07,720 --> 00:27:12,558
remember that's what we assume

654
00:27:09,679 --> 00:27:15,519
employment we call it n well I can

655
00:27:12,558 --> 00:27:18,038
rewrite n employment as the labor force

656
00:27:15,519 --> 00:27:21,359
times one minus the unemployment rate

657
00:27:18,038 --> 00:27:24,879
that's employment okay so that's I can

658
00:27:21,359 --> 00:27:27,918
think of output as that similar I can

659
00:27:24,880 --> 00:27:30,000
define a what we call we don't call it

660
00:27:27,919 --> 00:27:32,880
natur output we call it potential

661
00:27:30,000 --> 00:27:36,440
output no and potential output is

662
00:27:32,880 --> 00:27:38,120
defined as as the output that you get

663
00:27:36,440 --> 00:27:40,840
when unemployment is at the natural rate

664
00:27:38,119 --> 00:27:43,119
of unemployment okay so that's a

665
00:27:40,839 --> 00:27:46,398
definition three lines the potential

666
00:27:43,119 --> 00:27:49,798
output is when

667
00:27:46,398 --> 00:27:51,038
when the output you get which in this

668
00:27:49,798 --> 00:27:53,038
with this production function is the

669
00:27:51,038 --> 00:27:55,079
employment you get when you're at the

670
00:27:53,038 --> 00:27:57,319
unemployment at the natural rate of

671
00:27:55,079 --> 00:28:00,079
unemployment and now I can construct the

672
00:27:57,319 --> 00:28:02,038
difference the minus that this is

673
00:28:00,079 --> 00:28:03,759
something we call the output Gap and you

674
00:28:02,038 --> 00:28:07,519
may

675
00:28:03,759 --> 00:28:11,158
hear typically when people talk

676
00:28:07,519 --> 00:28:13,640
about issues of monetary

677
00:28:11,159 --> 00:28:16,399
policy often is described in terms of

678
00:28:13,640 --> 00:28:17,919
this variable More Than This Gap say

679
00:28:16,398 --> 00:28:20,239
people talk about the output Gap if the

680
00:28:17,919 --> 00:28:22,159
output Gap is positive that means output

681
00:28:20,240 --> 00:28:24,359
is above the natural rate of out the

682
00:28:22,159 --> 00:28:26,799
potential output when the output Gap is

683
00:28:24,359 --> 00:28:29,240
negative output is below potential

684
00:28:26,798 --> 00:28:32,038
output so I can re write this you know

685
00:28:29,240 --> 00:28:37,200
this minus that is just that and now I

686
00:28:32,038 --> 00:28:41,079
can I can replace uus un n here for H

687
00:28:37,200 --> 00:28:43,519
minus Yus YN / L and I get the Philips

688
00:28:41,079 --> 00:28:46,000
curve now written in terms of the output

689
00:28:43,519 --> 00:28:48,880
Gap and inflation so this says when

690
00:28:46,000 --> 00:28:50,960
output is above potential output when

691
00:28:48,880 --> 00:28:53,600
the output Gap is positive then

692
00:28:50,960 --> 00:28:55,558
inflation exceed expected inflation

693
00:28:53,599 --> 00:28:58,398
conversely when output is below

694
00:28:55,558 --> 00:29:01,240
potential output then inflation is below

695
00:28:58,398 --> 00:29:02,918
expected inflation okay but the logic is

696
00:29:01,240 --> 00:29:05,880
exactly the same as the logic we had

697
00:29:02,919 --> 00:29:07,480
here why is that this happens well

698
00:29:05,880 --> 00:29:09,080
because when output is above the

699
00:29:07,480 --> 00:29:10,839
potential output that means also

700
00:29:09,079 --> 00:29:14,480
unemployment is lower than the natural

701
00:29:10,839 --> 00:29:17,398
rate of unemployment okay so that's a

702
00:29:14,480 --> 00:29:19,440
that's the logic any question about

703
00:29:17,398 --> 00:29:23,479
this

704
00:29:19,440 --> 00:29:28,399
no okay good so anyway so now we have a

705
00:29:23,480 --> 00:29:31,000
a Philips curve and our aslm model so so

706
00:29:28,398 --> 00:29:33,158
let's put them together and suppose for

707
00:29:31,000 --> 00:29:35,720
now and when last example when I carry

708
00:29:33,159 --> 00:29:38,080
around is that expected inflation is

709
00:29:35,720 --> 00:29:39,519
equal to lag inflation so this a case in

710
00:29:38,079 --> 00:29:41,000
which expected inflation is not well

711
00:29:39,519 --> 00:29:42,240
anchor and then we're want to talk about

712
00:29:41,000 --> 00:29:45,398
what happens when it's anchor and not

713
00:29:42,240 --> 00:29:47,640
anchor so suppose that that inflation is

714
00:29:45,398 --> 00:29:49,000
actually whatever is this year's

715
00:29:47,640 --> 00:29:52,759
inflation that's what you expect for

716
00:29:49,000 --> 00:29:55,759
next year okay so here I have an example

717
00:29:52,759 --> 00:29:57,440
in which here I'm plotting our islm now

718
00:29:55,759 --> 00:30:00,679
which I'm using remember the real

719
00:29:57,440 --> 00:30:02,320
interest right here here H and in this

720
00:30:00,679 --> 00:30:04,519
diagram down here I'm plotting the

721
00:30:02,319 --> 00:30:08,000
Philips

722
00:30:04,519 --> 00:30:10,519
curve okay so first thing let's look

723
00:30:08,000 --> 00:30:13,038
about this Philip SC why is that where

724
00:30:10,519 --> 00:30:16,079
sloping here is output so this this is a

725
00:30:13,038 --> 00:30:17,319
parameter Pi n so and and and this is

726
00:30:16,079 --> 00:30:19,879
the left hand side variable so it's

727
00:30:17,319 --> 00:30:22,639
obviously increasing in output why is

728
00:30:19,880 --> 00:30:24,760
that well because if output grows that

729
00:30:22,640 --> 00:30:28,080
means unemployment goes down that means

730
00:30:24,759 --> 00:30:32,319
wages go up prices go up and you get

731
00:30:28,079 --> 00:30:33,759
inflation that's a mechanism okay so in

732
00:30:32,319 --> 00:30:36,319
this particular

733
00:30:33,759 --> 00:30:38,200
example we have this is the real

734
00:30:36,319 --> 00:30:40,960
interest rate that the FED has set at

735
00:30:38,200 --> 00:30:43,360
this moment that's equilibrium output

736
00:30:40,960 --> 00:30:45,038
what I'm trying to tell you here is that

737
00:30:43,359 --> 00:30:46,759
nothing has change in the way you

738
00:30:45,038 --> 00:30:49,038
calculate equilibrium output you just

739
00:30:46,759 --> 00:30:50,599
use for that you only need the stop

740
00:30:49,038 --> 00:30:52,798
diagram in the short

741
00:30:50,599 --> 00:30:56,918
run I tell you what the real interest

742
00:30:52,798 --> 00:30:58,480
rate is set by the is which is a

743
00:30:56,919 --> 00:31:01,320
decision by the Fed

744
00:30:58,480 --> 00:31:04,000
then I know where my is is I can pin

745
00:31:01,319 --> 00:31:07,359
down output I don't need this diagram to

746
00:31:04,000 --> 00:31:11,599
really pin down equilibrium output

747
00:31:07,359 --> 00:31:14,319
okay nothing is different there

748
00:31:11,599 --> 00:31:17,719
but and this is an example in this

749
00:31:14,319 --> 00:31:19,000
particular case we have that inflation

750
00:31:17,720 --> 00:31:22,798
is rising

751
00:31:19,000 --> 00:31:25,119
here and the question is why so for this

752
00:31:22,798 --> 00:31:27,679
what I'm trying to say is that for this

753
00:31:25,119 --> 00:31:30,319
is which is a function of fiscal policy

754
00:31:27,679 --> 00:31:33,278
of how confident consumers are and stuff

755
00:31:30,319 --> 00:31:35,519
like that if the FED chooses this real

756
00:31:33,278 --> 00:31:36,919
interest rate we end up with this output

757
00:31:35,519 --> 00:31:40,319
but it turns out that this level of

758
00:31:36,919 --> 00:31:42,559
output is increasing

759
00:31:40,319 --> 00:31:44,319
inflation and the increase in inflation

760
00:31:42,558 --> 00:31:47,798
I can read here I see the change in

761
00:31:44,319 --> 00:31:49,839
inflation is positive here why is this

762
00:31:47,798 --> 00:31:51,278
happening um if you're changing the

763
00:31:49,839 --> 00:31:54,000
alpha that means you have a different

764
00:31:51,278 --> 00:31:57,919
level ofemployment which changes the um

765
00:31:54,000 --> 00:32:00,119
expected inflation R yeah well actually

766
00:31:57,919 --> 00:32:01,480
here I don't need to take take this

767
00:32:00,119 --> 00:32:04,798
diagram would have also work with

768
00:32:01,480 --> 00:32:06,679
expected inflation as a constant here

769
00:32:04,798 --> 00:32:09,038
I'm I'm more looking at what happens to

770
00:32:06,679 --> 00:32:10,320
inflation I'm saying if output is above

771
00:32:09,038 --> 00:32:12,440
the natural rate of output then

772
00:32:10,319 --> 00:32:13,759
inflation is above expected inflation

773
00:32:12,440 --> 00:32:15,960
but I can take expected inflation as a

774
00:32:13,759 --> 00:32:18,000
constant in fact here it is a constant

775
00:32:15,960 --> 00:32:19,919
because constant in the sense that is

776
00:32:18,000 --> 00:32:22,240
given at time T because it's a previous

777
00:32:19,919 --> 00:32:23,919
year's inflation but what is important

778
00:32:22,240 --> 00:32:26,798
is that you have too much aggregate

779
00:32:23,919 --> 00:32:31,080
demand this economy is running very hot

780
00:32:26,798 --> 00:32:33,038
if output is positive then that is going

781
00:32:31,079 --> 00:32:34,599
to lead to inflationary pressures in

782
00:32:33,038 --> 00:32:36,200
this particular model where expected

783
00:32:34,599 --> 00:32:37,959
inflation is equal to l inflation this

784
00:32:36,200 --> 00:32:39,880
is pretty bad because not only you get

785
00:32:37,960 --> 00:32:42,880
inflation above the target of the FED

786
00:32:39,880 --> 00:32:45,799
but inflation is rising over

787
00:32:42,880 --> 00:32:47,760
time so this is a case in which this

788
00:32:45,798 --> 00:32:49,319
Central Bank is setting the real

789
00:32:47,759 --> 00:32:52,440
interest rate too

790
00:32:49,319 --> 00:32:54,879
low okay now you may want Japan is doing

791
00:32:52,440 --> 00:32:56,639
a little bit of this but they have a

792
00:32:54,880 --> 00:32:58,320
reason is that they have had inflation

793
00:32:56,638 --> 00:33:00,079
so low that it makes sense for them to

794
00:32:58,319 --> 00:33:02,599
build a little a little

795
00:33:00,079 --> 00:33:04,398
inflation in the US it made less sense

796
00:33:02,599 --> 00:33:05,839
remember the US got into trouble because

797
00:33:04,398 --> 00:33:07,558
it was in a situation like this for a

798
00:33:05,839 --> 00:33:10,638
long period of time I mean the you the

799
00:33:07,558 --> 00:33:12,839
reason we have today 6% inflation well

800
00:33:10,638 --> 00:33:16,398
depends which indicator you use is

801
00:33:12,839 --> 00:33:19,119
because the US experience sort of a year

802
00:33:16,398 --> 00:33:21,079
with a situation like this a year and a

803
00:33:19,119 --> 00:33:23,319
half okay and that's what sometimes

804
00:33:21,079 --> 00:33:25,398
people said the Fed was behind the curve

805
00:33:23,319 --> 00:33:28,079
they they for for a variety of reasons

806
00:33:25,398 --> 00:33:30,599
one initially potential output the Cline

807
00:33:28,079 --> 00:33:32,240
because of all the covid related issues

808
00:33:30,599 --> 00:33:34,199
they expected that to recover quickly so

809
00:33:32,240 --> 00:33:35,798
they says well let it go because I'm not

810
00:33:34,200 --> 00:33:37,278
going to start moving my policy right

811
00:33:35,798 --> 00:33:39,798
around for something that will recover

812
00:33:37,278 --> 00:33:41,880
quickly as soon as Co is gone well it

813
00:33:39,798 --> 00:33:43,960
took longer to recover and then it came

814
00:33:41,880 --> 00:33:46,799
the sort of the Russian war shock and so

815
00:33:43,960 --> 00:33:50,159
on and so natural rate of unemployment

816
00:33:46,798 --> 00:33:52,960
moved to the left to start and second

817
00:33:50,159 --> 00:33:55,880
because of an enormous policy support

818
00:33:52,960 --> 00:33:58,360
primarily H and the fact that that

819
00:33:55,880 --> 00:34:01,039
houses were able to save a lot during

820
00:33:58,359 --> 00:34:03,398
it there was a lot of pent up demand

821
00:34:01,038 --> 00:34:05,079
then we had enormous aggregate demand

822
00:34:03,398 --> 00:34:07,199
when we came out of it and the real

823
00:34:05,079 --> 00:34:09,319
interestate that we had was just way too

824
00:34:07,200 --> 00:34:10,519
low for all that agregate demand and

825
00:34:09,320 --> 00:34:13,240
that

826
00:34:10,519 --> 00:34:14,918
low potential output so we were in a

827
00:34:13,239 --> 00:34:15,878
situation like this and inflation began

828
00:34:14,918 --> 00:34:19,000
to

829
00:34:15,878 --> 00:34:20,838
climb initially expected inflation was

830
00:34:19,000 --> 00:34:22,519
very well anchor and then we began to

831
00:34:20,838 --> 00:34:24,119
lose the anchor then we recover it and

832
00:34:22,519 --> 00:34:25,719
and now we're losing it again we shall

833
00:34:24,119 --> 00:34:27,838
see what happens after this current

834
00:34:25,719 --> 00:34:29,678
episode but that was exactly a situation

835
00:34:27,838 --> 00:34:32,239
of the US and of most economies around

836
00:34:29,679 --> 00:34:34,918
the world China is in a different story

837
00:34:32,239 --> 00:34:38,199
but in most economies around the world

838
00:34:34,918 --> 00:34:40,480
you certainly Europe all of them the UK

839
00:34:38,199 --> 00:34:43,000
Continental Europe and the UK Latin

840
00:34:40,480 --> 00:34:44,918
America when you look the situation was

841
00:34:43,000 --> 00:34:50,639
like that just real interest were way

842
00:34:44,918 --> 00:34:52,319
too low for a um um the natural rate the

843
00:34:50,639 --> 00:34:54,440
potential the level of the potential

844
00:34:52,320 --> 00:34:57,760
output we had at that time and so we got

845
00:34:54,440 --> 00:34:59,079
into situation like this

846
00:34:57,760 --> 00:35:01,079
okay so that's the short run in the

847
00:34:59,079 --> 00:35:03,160
short run if you have an interest rate

848
00:35:01,079 --> 00:35:04,640
that is very low I mean again in the

849
00:35:03,159 --> 00:35:06,838
short run you you know how to determine

850
00:35:04,639 --> 00:35:08,319
output given a real interest rate and

851
00:35:06,838 --> 00:35:10,000
then now you can say a little more say

852
00:35:08,320 --> 00:35:11,760
okay but that's going to put inflation

853
00:35:10,000 --> 00:35:13,440
it's going to cause inflationary

854
00:35:11,760 --> 00:35:14,720
pressures up or down depending on

855
00:35:13,440 --> 00:35:16,358
whether you are to the right or to the

856
00:35:14,719 --> 00:35:18,118
left of the natural rate of output

857
00:35:16,358 --> 00:35:21,000
that's a new twist about the short run

858
00:35:18,119 --> 00:35:23,680
that you know but now let's start moving

859
00:35:21,000 --> 00:35:26,960
over time so what happens over

860
00:35:23,679 --> 00:35:30,118
time well first let me Define something

861
00:35:26,960 --> 00:35:31,519
well potential output we know what it is

862
00:35:30,119 --> 00:35:34,160
but I'm going to define something which

863
00:35:31,519 --> 00:35:36,079
is called the natural rate of interest

864
00:35:34,159 --> 00:35:37,440
rate sometimes called the neutral

865
00:35:36,079 --> 00:35:39,359
interest rate sometimes called the

866
00:35:37,440 --> 00:35:42,159
weelian interest rate let me not get

867
00:35:39,358 --> 00:35:45,279
into that story but I'm going to Define

868
00:35:42,159 --> 00:35:48,118
implicitly the natural rate of interest

869
00:35:45,280 --> 00:35:49,839
rate or the neutral rate of interest or

870
00:35:48,119 --> 00:35:52,720
some people call it rst star you may

871
00:35:49,838 --> 00:35:54,119
have heard of RS star in the newspapers

872
00:35:52,719 --> 00:35:55,719
people talk about R star when they are

873
00:35:54,119 --> 00:35:58,760
talking about RAR they're talking about

874
00:35:55,719 --> 00:36:01,799
that okay is simply the interest rate

875
00:35:58,760 --> 00:36:03,440
that that makes the natur the potential

876
00:36:01,800 --> 00:36:05,839
output the equilibrium of the Goods

877
00:36:03,440 --> 00:36:08,920
Market okay so I'm solving implicitly I

878
00:36:05,838 --> 00:36:10,199
say I want to get as a result as an I

879
00:36:08,920 --> 00:36:13,119
want to get as a result of this

880
00:36:10,199 --> 00:36:15,159
equilibrium here H the natural rate of

881
00:36:13,119 --> 00:36:17,079
output what is the interest I need to

882
00:36:15,159 --> 00:36:20,000
pick so that's the

883
00:36:17,079 --> 00:36:22,599
case okay so I want to get the natural

884
00:36:20,000 --> 00:36:24,280
rate of output here the potential output

885
00:36:22,599 --> 00:36:27,000
I know that there is an interest rate

886
00:36:24,280 --> 00:36:28,240
real interest rate at which that holds

887
00:36:27,000 --> 00:36:30,960
no it's a matter looking for the

888
00:36:28,239 --> 00:36:33,078
interest rate that does that and in this

889
00:36:30,960 --> 00:36:34,800
particular diagram is this you see at

890
00:36:33,079 --> 00:36:38,480
this interest

891
00:36:34,800 --> 00:36:40,720
rate the ASI equilibrium output is

892
00:36:38,480 --> 00:36:45,719
exactly the natural rate of

893
00:36:40,719 --> 00:36:49,000
output okay so what I know is that

894
00:36:45,719 --> 00:36:52,318
eventually the economy will have to go

895
00:36:49,000 --> 00:36:55,480
there no eventually the economy will

896
00:36:52,318 --> 00:36:59,800
have to go there so how will this happen

897
00:36:55,480 --> 00:37:01,159
in practice the way we happen is okay

898
00:36:59,800 --> 00:37:03,760
this is the point we were at in the

899
00:37:01,159 --> 00:37:06,039
previous slide

900
00:37:03,760 --> 00:37:08,520
no so we were

901
00:37:06,039 --> 00:37:10,800
here well that's building in

902
00:37:08,519 --> 00:37:13,159
inflationary

903
00:37:10,800 --> 00:37:15,880
pressure what do you think will happen

904
00:37:13,159 --> 00:37:15,879
inflation start

905
00:37:17,440 --> 00:37:25,440
climbing who will react who is in charge

906
00:37:21,280 --> 00:37:25,440
not letting inflation get get carried

907
00:37:25,679 --> 00:37:29,838
away Central Bank know the Fed so what

908
00:37:28,318 --> 00:37:30,920
they'll start doing is hiking interest

909
00:37:29,838 --> 00:37:33,358
rate which is exactly what they have

910
00:37:30,920 --> 00:37:35,519
been doing no and as they hike interest

911
00:37:33,358 --> 00:37:37,880
rate you know they're going to

912
00:37:35,519 --> 00:37:39,599
keep they take they start increasing the

913
00:37:37,880 --> 00:37:42,519
real interest rate interest until they

914
00:37:39,599 --> 00:37:47,160
get to this point okay that's

915
00:37:42,519 --> 00:37:51,639
idea so the point is that in the medium

916
00:37:47,159 --> 00:37:53,239
run a a the real interest real variables

917
00:37:51,639 --> 00:37:55,318
determine real variables not monetary

918
00:37:53,239 --> 00:37:56,719
policy monetary policy has to follow

919
00:37:55,318 --> 00:37:59,480
whatever it is that the economy throws

920
00:37:56,719 --> 00:38:00,919
at them banks have to follow whatever is

921
00:37:59,480 --> 00:38:02,679
the real interest rate if they made a

922
00:38:00,920 --> 00:38:04,519
mistake and they set an real interest

923
00:38:02,679 --> 00:38:06,358
rate which is not consistent with a

924
00:38:04,519 --> 00:38:08,199
stable inflation they're going to learn

925
00:38:06,358 --> 00:38:10,039
about it and over time they're going to

926
00:38:08,199 --> 00:38:14,799
have to fix that and when will the

927
00:38:10,039 --> 00:38:16,960
problem go away only when H they they

928
00:38:14,800 --> 00:38:19,359
reach the natural rate of unemployment

929
00:38:16,960 --> 00:38:21,480
okay and so that's what will happen as

930
00:38:19,358 --> 00:38:24,358
the real interest start going up from

931
00:38:21,480 --> 00:38:27,079
here to there then you start seeing the

932
00:38:24,358 --> 00:38:29,880
change in inflation this particular mole

933
00:38:27,079 --> 00:38:31,519
ER um declining and declining and when

934
00:38:29,880 --> 00:38:34,480
you get to an natural rate of output at

935
00:38:31,519 --> 00:38:34,480
least you get a stable

936
00:38:36,039 --> 00:38:42,440
inflation is this adjustment

937
00:38:39,838 --> 00:38:45,239
clear okay good okay so that's what

938
00:38:42,440 --> 00:38:47,440
happened in the medium run so the medium

939
00:38:45,239 --> 00:38:49,759
run is described as moving from that

940
00:38:47,440 --> 00:38:52,119
point here the whole process of going

941
00:38:49,760 --> 00:38:55,800
back to a situation where we converge to

942
00:38:52,119 --> 00:38:57,559
the Natural rate of interest rate and

943
00:38:55,800 --> 00:38:59,160
therefore the natural rate of output and

944
00:38:57,559 --> 00:39:01,920
the natural rate of unemployment and all

945
00:38:59,159 --> 00:39:03,960
these kind of things okay so that's the

946
00:39:01,920 --> 00:39:07,358
short run is whatever his output is

947
00:39:03,960 --> 00:39:10,318
That's So slm the medium run is whatever

948
00:39:07,358 --> 00:39:11,639
the the natural rate tells you should be

949
00:39:10,318 --> 00:39:13,039
the natural rate of unemployment the

950
00:39:11,639 --> 00:39:15,078
natural rate of output and therefore the

951
00:39:13,039 --> 00:39:16,318
natural rate of interest rate or weelian

952
00:39:15,079 --> 00:39:19,960
interest rate or the neutral interest

953
00:39:16,318 --> 00:39:21,960
rate or our star that's all pinned down

954
00:39:19,960 --> 00:39:23,679
there in the in the in the medium run

955
00:39:21,960 --> 00:39:26,358
and the transition is obviously going

956
00:39:23,679 --> 00:39:27,879
from the short run like pure LS slm to

957
00:39:26,358 --> 00:39:30,199
the Natural rate

958
00:39:27,880 --> 00:39:33,880
type analysis

959
00:39:30,199 --> 00:39:36,439
okay now I assume here and that's

960
00:39:33,880 --> 00:39:40,480
related to your answer I assume here

961
00:39:36,440 --> 00:39:42,838
that expected inflation was an anchor

962
00:39:40,480 --> 00:39:45,920
that is that expected inflation was

963
00:39:42,838 --> 00:39:48,318
equal to l inflation that's I I told you

964
00:39:45,920 --> 00:39:51,079
before that's not what Central One banks

965
00:39:48,318 --> 00:39:55,239
want to be because that means that if

966
00:39:51,079 --> 00:39:57,079
you mess up inflation is high and and

967
00:39:55,239 --> 00:39:58,679
then in order to bring it down you also

968
00:39:57,079 --> 00:40:00,440
have to bring down expected inflation

969
00:39:58,679 --> 00:40:02,598
you need to cause a recession and you

970
00:40:00,440 --> 00:40:04,800
can see that here so suppose that the

971
00:40:02,599 --> 00:40:06,160
Central Bank starts with the level of

972
00:40:04,800 --> 00:40:08,318
inflation that it like suppose that this

973
00:40:06,159 --> 00:40:09,960
is the model so what I said before the

974
00:40:08,318 --> 00:40:12,400
expected inflation is equal to lag

975
00:40:09,960 --> 00:40:14,000
inflation suppose that the Central Bank

976
00:40:12,400 --> 00:40:18,519
starts at the level of inflation that it

977
00:40:14,000 --> 00:40:21,960
likes 2% in the US okay I suppose that

978
00:40:18,519 --> 00:40:23,480
for whatever reason whatever shock it

979
00:40:21,960 --> 00:40:25,800
finds itself with an interest rate that

980
00:40:23,480 --> 00:40:29,400
is too low a real interest rate is too

981
00:40:25,800 --> 00:40:32,359
low that means in inflation exceeds

982
00:40:29,400 --> 00:40:35,519
expected inflation which was

983
00:40:32,358 --> 00:40:38,440
2% well by next year say this suppos

984
00:40:35,519 --> 00:40:40,920
this Gap is 2% well by next year the G

985
00:40:38,440 --> 00:40:45,559
inflation is

986
00:40:40,920 --> 00:40:48,400
4% okay so if your inflation is 4% in

987
00:40:45,559 --> 00:40:50,679
fact in the US it got to be 9% if you

988
00:40:48,400 --> 00:40:52,920
are at 9% level of inflation and this is

989
00:40:50,679 --> 00:40:55,679
the model of expected for expected

990
00:40:52,920 --> 00:40:57,838
inflation you have then Houston you have

991
00:40:55,679 --> 00:40:59,838
a problem because it's not enough with

992
00:40:57,838 --> 00:41:01,719
raising interest rate up to this point

993
00:40:59,838 --> 00:41:04,799
suppose that the FED says wow I don't

994
00:41:01,719 --> 00:41:06,480
like 9% I'm going to go back to that

995
00:41:04,800 --> 00:41:08,280
that clearly tells me that my output is

996
00:41:06,480 --> 00:41:09,800
way above the natural rate of output I'm

997
00:41:08,280 --> 00:41:11,800
going to hike interest rate and somebody

998
00:41:09,800 --> 00:41:14,359
tells the fed this is your natural

999
00:41:11,800 --> 00:41:15,519
interest rate a very good research

1000
00:41:14,358 --> 00:41:17,199
Department tells him look this is your

1001
00:41:15,519 --> 00:41:18,800
natural interest hike it to there

1002
00:41:17,199 --> 00:41:20,399
suppose the FED hikes the interest rate

1003
00:41:18,800 --> 00:41:22,800
to that point what

1004
00:41:20,400 --> 00:41:25,358
happens so the FED realized here this

1005
00:41:22,800 --> 00:41:28,240
was going really wrong they end up with

1006
00:41:25,358 --> 00:41:30,159
9% inflation so but somebody tells him

1007
00:41:28,239 --> 00:41:32,959
look this is your natural your neutral

1008
00:41:30,159 --> 00:41:35,000
interest rate your R star bring it there

1009
00:41:32,960 --> 00:41:37,559
and the FED immediately reacts and takes

1010
00:41:35,000 --> 00:41:40,119
it there what

1011
00:41:37,559 --> 00:41:41,960
happened is the Fed happy with the final

1012
00:41:40,119 --> 00:41:44,760
outcome and supposed the res Department

1013
00:41:41,960 --> 00:41:48,519
was really good so they got got it right

1014
00:41:44,760 --> 00:41:51,280
so the r star was the right R

1015
00:41:48,519 --> 00:41:53,199
star okay and the FED implemented that

1016
00:41:51,280 --> 00:41:54,519
policy move interest rate suppose that

1017
00:41:53,199 --> 00:41:56,719
the interest rate the real interest rate

1018
00:41:54,519 --> 00:41:58,679
they had was minus 1% I'm telling you

1019
00:41:56,719 --> 00:42:02,000
numbers that are not that different from

1020
00:41:58,679 --> 00:42:04,000
what we had minus 1% and and and the

1021
00:42:02,000 --> 00:42:06,880
research Department tells no your your

1022
00:42:04,000 --> 00:42:08,719
RN is really 1% so they hike interest

1023
00:42:06,880 --> 00:42:12,240
rate by 2%

1024
00:42:08,719 --> 00:42:12,239
immediately and now what

1025
00:42:19,838 --> 00:42:23,679
happens

1026
00:42:21,358 --> 00:42:25,598
so I guess that question is a little

1027
00:42:23,679 --> 00:42:28,519
bague but but I'm saying is the Central

1028
00:42:25,599 --> 00:42:31,920
Bank happy now that it o I got we got

1029
00:42:28,519 --> 00:42:33,719
the right natural rate neutral rate it's

1030
00:42:31,920 --> 00:42:36,039
called neutral

1031
00:42:33,719 --> 00:42:37,959
rate well I'm telling you I wouldn't be

1032
00:42:36,039 --> 00:42:39,759
asking you if the Fed was happy after

1033
00:42:37,960 --> 00:42:42,318
that so why do you think why why are

1034
00:42:39,760 --> 00:42:45,680
they unhappy why is the Fed unhappy

1035
00:42:42,318 --> 00:42:47,440
after that not unhappy with the policy

1036
00:42:45,679 --> 00:42:49,039
but but but when I'm saying the

1037
00:42:47,440 --> 00:42:51,838
adjustment is not completed at that

1038
00:42:49,039 --> 00:42:51,838
point

1039
00:42:56,119 --> 00:43:01,119
why and I'm trying to make the bigger

1040
00:42:58,400 --> 00:43:02,720
point for why central banks are so eager

1041
00:43:01,119 --> 00:43:04,640
to maintain credibility and not have

1042
00:43:02,719 --> 00:43:06,838
this kind of model of expected inflation

1043
00:43:04,639 --> 00:43:08,719
they want the markets to believe them

1044
00:43:06,838 --> 00:43:10,838
that that they have a Target and that

1045
00:43:08,719 --> 00:43:12,598
they're going to go to that Target and

1046
00:43:10,838 --> 00:43:14,358
and that to set their expected inflation

1047
00:43:12,599 --> 00:43:16,440
equal to that constant equal to a Target

1048
00:43:14,358 --> 00:43:18,239
that's what they dream with because if

1049
00:43:16,440 --> 00:43:20,280
they don't get that if they get this

1050
00:43:18,239 --> 00:43:22,519
instead things are

1051
00:43:20,280 --> 00:43:26,079
nasty and I'm trying to describe that

1052
00:43:22,519 --> 00:43:27,920
Nas what what what is happening now so

1053
00:43:26,079 --> 00:43:31,039
what happens here okay so so so we went

1054
00:43:27,920 --> 00:43:33,079
here inflation got to be 9% and now the

1055
00:43:31,039 --> 00:43:36,318
FED boom hike interest rate

1056
00:43:33,079 --> 00:43:38,280
by 200 basis point it got to the Natural

1057
00:43:36,318 --> 00:43:39,519
rate we're back at output equal to

1058
00:43:38,280 --> 00:43:42,200
Natural rate of output what is happening

1059
00:43:39,519 --> 00:43:42,199
to inflation

1060
00:43:43,800 --> 00:43:48,720
here so now we're back at the natural

1061
00:43:46,318 --> 00:43:51,239
what is happening to

1062
00:43:48,719 --> 00:43:53,480
inflation well this diagram tells you

1063
00:43:51,239 --> 00:43:55,879
something very specific it says it's not

1064
00:43:53,480 --> 00:43:58,440
changing so now your inflation at least

1065
00:43:55,880 --> 00:44:00,559
is not changing

1066
00:43:58,440 --> 00:44:03,079
okay so that's

1067
00:44:00,559 --> 00:44:07,800
good at least not Rising here it was

1068
00:44:03,079 --> 00:44:10,160
Rising it's not changing but what is the

1069
00:44:07,800 --> 00:44:12,079
problem inflation not changing when

1070
00:44:10,159 --> 00:44:15,480
you're at 9% is not a good outcome for

1071
00:44:12,079 --> 00:44:18,559
the FED want 2% not

1072
00:44:15,480 --> 00:44:20,318
9% okay so they when you have this

1073
00:44:18,559 --> 00:44:22,400
modification you need to do more than

1074
00:44:20,318 --> 00:44:24,639
that you know because you need to bring

1075
00:44:22,400 --> 00:44:26,720
expected inflation down so you need to

1076
00:44:24,639 --> 00:44:29,239
overshoot a Fed that finds itself with

1077
00:44:26,719 --> 00:44:32,118
9% inflation and has expected inflation

1078
00:44:29,239 --> 00:44:34,358
and anchor needs to be inflation much

1079
00:44:32,119 --> 00:44:35,720
lower so needs to raise interest in the

1080
00:44:34,358 --> 00:44:37,519
short run much higher than the natural

1081
00:44:35,719 --> 00:44:39,919
rate of interest rate so it gets

1082
00:44:37,519 --> 00:44:41,440
negative inflation here so you can bring

1083
00:44:39,920 --> 00:44:45,920
the 9% back to

1084
00:44:41,440 --> 00:44:48,880
2% no so I have to generate a minus 7%

1085
00:44:45,920 --> 00:44:51,240
here and to generate a minus 7% here I

1086
00:44:48,880 --> 00:44:52,760
need to bring output much below the

1087
00:44:51,239 --> 00:44:55,519
natural rate of output I need to cause a

1088
00:44:52,760 --> 00:44:57,760
big recession to do that and that's the

1089
00:44:55,519 --> 00:45:00,119
reason the bank central banks don't want

1090
00:44:57,760 --> 00:45:03,240
to be in this scenario because with this

1091
00:45:00,119 --> 00:45:05,280
of inflation if expected inflation

1092
00:45:03,239 --> 00:45:06,959
becomes an anchor then there's no way

1093
00:45:05,280 --> 00:45:09,000
around that the FED will have to cause a

1094
00:45:06,960 --> 00:45:11,079
big recession to get out of inflationary

1095
00:45:09,000 --> 00:45:14,000
problem

1096
00:45:11,079 --> 00:45:15,760
okay contrast that with a case in which

1097
00:45:14,000 --> 00:45:17,838
the market the expected inflation is not

1098
00:45:15,760 --> 00:45:19,839
equal to lag inflation but is equal to

1099
00:45:17,838 --> 00:45:23,119
whatever the FED tells them is the long

1100
00:45:19,838 --> 00:45:25,719
run average 2% so now suppose that

1101
00:45:23,119 --> 00:45:28,800
therefore rather than having here Pi

1102
00:45:25,719 --> 00:45:33,799
minus one I have that Target Pi Bar

1103
00:45:28,800 --> 00:45:36,839
which is 2% so yeah we got to 9% but for

1104
00:45:33,800 --> 00:45:39,440
the FED to go back to say the FED would

1105
00:45:36,838 --> 00:45:41,279
say whoop I mess up you know clearly set

1106
00:45:39,440 --> 00:45:43,599
a real interest that was way too low and

1107
00:45:41,280 --> 00:45:45,519
so I end up with 9% inflation but if

1108
00:45:43,599 --> 00:45:48,280
credibility is maintained and still

1109
00:45:45,519 --> 00:45:49,719
people expect 2% in the medium run then

1110
00:45:48,280 --> 00:45:51,920
that means that the FED doesn't need to

1111
00:45:49,719 --> 00:45:54,439
cause a recession to bring inflation

1112
00:45:51,920 --> 00:45:57,559
back to the normal level it just needs

1113
00:45:54,440 --> 00:46:00,480
to bring output to a level equal to

1114
00:45:57,559 --> 00:46:03,319
potential out so it just need to raise

1115
00:46:00,480 --> 00:46:06,679
interest to RN to the Natural rate of

1116
00:46:03,318 --> 00:46:08,119
the r star not to our Star Plus

1117
00:46:06,679 --> 00:46:12,000
something in order to have this

1118
00:46:08,119 --> 00:46:13,640
inflation in the short okay and we're

1119
00:46:12,000 --> 00:46:14,800
there at this moment in the verge of

1120
00:46:13,639 --> 00:46:18,039
these two worlds we have been

1121
00:46:14,800 --> 00:46:20,960
alternating between the two worlds still

1122
00:46:18,039 --> 00:46:22,679
more biased towards the good World in

1123
00:46:20,960 --> 00:46:25,000
which really the FED doesn't need to

1124
00:46:22,679 --> 00:46:26,399
cause a the need the FED needs to slow

1125
00:46:25,000 --> 00:46:29,199
down the economy because it still need

1126
00:46:26,400 --> 00:46:31,760
to bring out put down to YN but that's a

1127
00:46:29,199 --> 00:46:33,358
small change in practice all these

1128
00:46:31,760 --> 00:46:35,480
things are growing over time it just

1129
00:46:33,358 --> 00:46:39,440
means that the economy grows at a lower

1130
00:46:35,480 --> 00:46:40,519
pace for a few quarters okay but it's

1131
00:46:39,440 --> 00:46:42,559
very different to have to bring

1132
00:46:40,519 --> 00:46:45,000
temporarily output down here because for

1133
00:46:42,559 --> 00:46:46,359
that you need to sort of bring the

1134
00:46:45,000 --> 00:46:48,760
growth has to become

1135
00:46:46,358 --> 00:46:52,440
negative for some period of time in

1136
00:46:48,760 --> 00:46:54,480
order to bring inflation

1137
00:46:52,440 --> 00:46:58,480
down

1138
00:46:54,480 --> 00:46:58,480
good so

1139
00:46:58,599 --> 00:47:04,200
big lessons from uh this part is that as

1140
00:47:01,519 --> 00:47:06,000
I said before in the M run so so I

1141
00:47:04,199 --> 00:47:07,358
haven't changed at I haven't changed any

1142
00:47:06,000 --> 00:47:09,039
of the two models I told you what was

1143
00:47:07,358 --> 00:47:11,838
the model of the short run the slm

1144
00:47:09,039 --> 00:47:13,079
that's still true here I told you then

1145
00:47:11,838 --> 00:47:15,039
what was the model of the natural rate

1146
00:47:13,079 --> 00:47:16,559
of unemployment and all that and that

1147
00:47:15,039 --> 00:47:17,920
there we didn't have any monetary policy

1148
00:47:16,559 --> 00:47:19,760
or anything like that we we look at what

1149
00:47:17,920 --> 00:47:20,960
happened in the labor market and we

1150
00:47:19,760 --> 00:47:25,680
determin the natural rate of an

1151
00:47:20,960 --> 00:47:27,440
employment and that was it okay so so

1152
00:47:25,679 --> 00:47:29,078
the medium run here is when we are in

1153
00:47:27,440 --> 00:47:32,000
that world which has nothing to do with

1154
00:47:29,079 --> 00:47:34,440
monetary policy it has all to do with

1155
00:47:32,000 --> 00:47:36,760
real variables okay what is a n what is

1156
00:47:34,440 --> 00:47:38,240
a equilibrium long-ter real interest

1157
00:47:36,760 --> 00:47:40,839
rate what is a natural rate of

1158
00:47:38,239 --> 00:47:45,399
unemployment things of that

1159
00:47:40,838 --> 00:47:48,119
kind um but monetary policy what does do

1160
00:47:45,400 --> 00:47:50,680
is certainly determine in the short run

1161
00:47:48,119 --> 00:47:52,880
equilibrium output and but in the medium

1162
00:47:50,679 --> 00:47:54,399
run it's is determines what is the

1163
00:47:52,880 --> 00:47:55,720
nominal interest rate equilibrium

1164
00:47:54,400 --> 00:47:58,920
nominal interest rate and the level of

1165
00:47:55,719 --> 00:48:01,639
inflation because the economy will have

1166
00:47:58,920 --> 00:48:05,400
a real interest rate which is the rst

1167
00:48:01,639 --> 00:48:07,598
star and RN the economy has RN but the

1168
00:48:05,400 --> 00:48:10,280
fed and the FED will not get to pick

1169
00:48:07,599 --> 00:48:12,599
what RN is the only thing that the FED

1170
00:48:10,280 --> 00:48:14,280
will get to pick in the medium run is

1171
00:48:12,599 --> 00:48:16,519
what is a nominal interest rate that is

1172
00:48:14,280 --> 00:48:19,440
consistent with that RN because supposed

1173
00:48:16,519 --> 00:48:22,679
the RN is say

1174
00:48:19,440 --> 00:48:25,318
2% if the if the economy ends up having

1175
00:48:22,679 --> 00:48:27,598
3% inflation on average that means that

1176
00:48:25,318 --> 00:48:29,159
the nominal interest r rate for the long

1177
00:48:27,599 --> 00:48:32,280
run is going to have to be

1178
00:48:29,159 --> 00:48:33,759
5% is instead that economy has 2%

1179
00:48:32,280 --> 00:48:35,640
inflation average then that means that

1180
00:48:33,760 --> 00:48:38,720
the the long run nominal interest rate

1181
00:48:35,639 --> 00:48:40,159
will be 4% so monetary policy affects

1182
00:48:38,719 --> 00:48:42,118
the nominal interest rate nominal

1183
00:48:40,159 --> 00:48:43,358
variables in the M run but not the real

1184
00:48:42,119 --> 00:48:45,440
variables the real variables are

1185
00:48:43,358 --> 00:48:47,880
determined by the real sector and that's

1186
00:48:45,440 --> 00:48:50,760
often refer as the neutrality of money

1187
00:48:47,880 --> 00:48:52,798
in the medium run and the long run money

1188
00:48:50,760 --> 00:48:54,400
tends to be neutral and that's that's

1189
00:48:52,798 --> 00:48:56,838
what it means

1190
00:48:54,400 --> 00:48:58,599
that real variables are determined by

1191
00:48:56,838 --> 00:49:00,759
something entirely different but in the

1192
00:48:58,599 --> 00:49:03,359
short run monetary policy is the main

1193
00:49:00,760 --> 00:49:06,040
game game in town and in the medium run

1194
00:49:03,358 --> 00:49:08,400
it's just about inflation it's not about

1195
00:49:06,039 --> 00:49:11,159
real

1196
00:49:08,400 --> 00:49:16,599
activity

1197
00:49:11,159 --> 00:49:16,598
um Let me let me stop here