1 00:00:16,719 --> 00:00:22,879 um so we started with the something a 2 00:00:20,079 --> 00:00:25,079 little boring basic definitions and the 3 00:00:22,879 --> 00:00:26,480 first thing we had to do is to 4 00:00:25,079 --> 00:00:28,198 understand how do we measure output at 5 00:00:26,480 --> 00:00:29,599 the aggregate level it's very easy to 6 00:00:28,199 --> 00:00:32,679 understand what output is at the level 7 00:00:29,599 --> 00:00:36,200 of an Factory but but at the AG level is 8 00:00:32,679 --> 00:00:38,799 a little tricky and so we had an example 9 00:00:36,200 --> 00:00:41,440 of a very simple economy with two 10 00:00:38,799 --> 00:00:44,439 companies one that produces steel and 11 00:00:41,439 --> 00:00:46,359 the other one that produces cars and in 12 00:00:44,439 --> 00:00:47,799 this particular example the steel 13 00:00:46,359 --> 00:00:50,079 company doesn't sell anything to the 14 00:00:47,799 --> 00:00:52,599 final consumers it sells all its 15 00:00:50,079 --> 00:00:54,640 production to the car company and we ask 16 00:00:52,600 --> 00:00:58,120 a question where is the GDP of this 17 00:00:54,640 --> 00:01:01,640 economy H the simplest answer would have 18 00:00:58,119 --> 00:01:03,439 been well 300 no I some what the the the 19 00:01:01,640 --> 00:01:06,879 output of the two companies and that 20 00:01:03,439 --> 00:01:08,719 could be one answer but then I show you 21 00:01:06,879 --> 00:01:12,599 through three different methods that 22 00:01:08,719 --> 00:01:18,319 that's the wrong answer and um method 23 00:01:12,599 --> 00:01:22,438 one H was h a definition is um GDP is 24 00:01:18,319 --> 00:01:25,438 the value of final goods only okay and 25 00:01:22,438 --> 00:01:26,959 final goods in this simple example is 26 00:01:25,438 --> 00:01:29,399 well this company is not producing 27 00:01:26,959 --> 00:01:31,919 anything as a final good because all its 28 00:01:29,400 --> 00:01:34,960 sales are going to as an input into 29 00:01:31,920 --> 00:01:36,799 other companies production and so this 30 00:01:34,959 --> 00:01:38,839 one doesn't count at all in our simple 31 00:01:36,799 --> 00:01:42,560 example this one counts and then the 32 00:01:38,840 --> 00:01:46,520 answer is $200 okay not 3300 but 33 00:01:42,560 --> 00:01:48,840 $200 method two was to count only the 34 00:01:46,519 --> 00:01:50,798 value added in each company and value 35 00:01:48,840 --> 00:01:51,920 added is the difference between the 36 00:01:50,799 --> 00:01:55,159 final 37 00:01:51,920 --> 00:01:57,640 output that is the revenue from sales 38 00:01:55,159 --> 00:02:00,280 minus whatever that company spends on 39 00:01:57,640 --> 00:02:02,319 intermediate inputs in this simple 40 00:02:00,280 --> 00:02:04,200 example this company the steel company 41 00:02:02,319 --> 00:02:05,959 is not spending anything on intermediate 42 00:02:04,200 --> 00:02:07,959 inputs it's a strange production of a 43 00:02:05,959 --> 00:02:11,000 steel but anyways it is what it is in 44 00:02:07,959 --> 00:02:13,400 example and so this is entire this $100 45 00:02:11,000 --> 00:02:15,519 is is value added completely value added 46 00:02:13,400 --> 00:02:18,719 there's no expenses on intermediate 47 00:02:15,519 --> 00:02:20,959 inputs for the car company however the 48 00:02:18,719 --> 00:02:23,359 revenue from C is 200 but the company 49 00:02:20,959 --> 00:02:25,039 spends 100 on intermediate input 50 00:02:23,360 --> 00:02:27,680 therefore the value out of this company 51 00:02:25,039 --> 00:02:29,719 is 200 minus 100 so you get 100 value 52 00:02:27,680 --> 00:02:33,239 out from this one 100 value out from 53 00:02:29,719 --> 00:02:35,759 that one total value added 200 so same 54 00:02:33,239 --> 00:02:37,640 answer and the third method these are 55 00:02:35,759 --> 00:02:39,439 the two method that I just described are 56 00:02:37,639 --> 00:02:42,238 production methods no you're measuring 57 00:02:39,439 --> 00:02:45,400 the production side the alternative is 58 00:02:42,239 --> 00:02:47,640 to look at the income side okay and the 59 00:02:45,400 --> 00:02:49,840 income side let's says just let's sum 60 00:02:47,639 --> 00:02:52,000 all the incomes in the economy and the 61 00:02:49,840 --> 00:02:54,319 incomes are income to workers wages and 62 00:02:52,000 --> 00:02:58,120 income to the owners of capital 63 00:02:54,318 --> 00:03:02,359 profits ER income to way to workers is 64 00:02:58,120 --> 00:03:05,439 $80 plus 70 is 100 50 income to owners 65 00:03:02,360 --> 00:03:08,120 of capital is 20 + 30 that's 50 so 150 66 00:03:05,439 --> 00:03:11,840 plus 50 is again 200 okay so these are 67 00:03:08,120 --> 00:03:15,280 three equivalent ways of er er measuring 68 00:03:11,840 --> 00:03:18,200 output and I said 69 00:03:15,280 --> 00:03:21,439 ER you know and one of the features I I 70 00:03:18,199 --> 00:03:25,079 I I show you of of of of this method is 71 00:03:21,439 --> 00:03:26,919 that they are immune to organizational 72 00:03:25,080 --> 00:03:28,640 structure within the economy so for 73 00:03:26,919 --> 00:03:31,639 example if these two companies were to 74 00:03:28,639 --> 00:03:34,598 merge no clearly the sum of incomes 75 00:03:31,639 --> 00:03:36,039 would not change would still be 100 it 76 00:03:34,598 --> 00:03:39,318 would be 77 00:03:36,039 --> 00:03:41,479 200 ER this one would not change because 78 00:03:39,318 --> 00:03:43,679 if they were to merge then the whole 79 00:03:41,479 --> 00:03:46,438 production of the revenues from sales of 80 00:03:43,680 --> 00:03:48,159 the car company would be value added 81 00:03:46,438 --> 00:03:50,400 everything would be produced in house 82 00:03:48,158 --> 00:03:51,919 and still the answer would be 200 then 83 00:03:50,400 --> 00:03:53,879 no because this company would disappear 84 00:03:51,919 --> 00:03:56,878 it would emerge inside here and you 85 00:03:53,878 --> 00:04:00,639 would get still get 200 and the same 86 00:03:56,878 --> 00:04:03,359 happen with h method one because still 87 00:04:00,639 --> 00:04:06,359 the sales of final goods is only 88 00:04:03,360 --> 00:04:09,079 200 the naive approach of just summing 89 00:04:06,360 --> 00:04:11,159 output you know would be terrible 90 00:04:09,079 --> 00:04:13,879 because once you merge it output would 91 00:04:11,158 --> 00:04:16,159 collapse from 300 to 200 that tells you 92 00:04:13,878 --> 00:04:18,560 that's not the right way of doing things 93 00:04:16,160 --> 00:04:22,840 okay so while the three methods we 94 00:04:18,560 --> 00:04:24,519 propose do H work are immune to to this 95 00:04:22,839 --> 00:04:28,039 organiz changes in organization 96 00:04:24,519 --> 00:04:30,038 structure The Next Step was to H 97 00:04:28,040 --> 00:04:32,879 highlight that when we say out output 98 00:04:30,038 --> 00:04:34,319 we're really after real output and 99 00:04:32,879 --> 00:04:37,639 there's a distinction between nominal 100 00:04:34,319 --> 00:04:39,879 output and real output nominal output is 101 00:04:37,639 --> 00:04:43,439 simply the quantity of final goods 102 00:04:39,879 --> 00:04:46,199 measured at current prices while real 103 00:04:43,439 --> 00:04:49,199 output is measured at some fixed set of 104 00:04:46,199 --> 00:04:50,478 prices okay of one fixed year and I 105 00:04:49,199 --> 00:04:52,639 think I gave you an 106 00:04:50,478 --> 00:04:54,478 example this is example I gave you and 107 00:04:52,639 --> 00:04:56,160 then in the in the in the pets you had 108 00:04:54,478 --> 00:04:58,279 more complicated examples with multiple 109 00:04:56,160 --> 00:05:00,199 Goods here you have an economy that 110 00:04:58,279 --> 00:05:03,279 produces only one good 111 00:05:00,199 --> 00:05:06,720 cars and that PES 10 cars here 12 cars 112 00:05:03,279 --> 00:05:09,599 here 13 cars here the price of the cars 113 00:05:06,720 --> 00:05:12,240 is rising so the nominal GDP is rising a 114 00:05:09,600 --> 00:05:14,800 lot while the real GDP is rising less 115 00:05:12,240 --> 00:05:16,840 how do we measure real GDP here we use 116 00:05:14,800 --> 00:05:19,600 to to 12 in this particular example we 117 00:05:16,839 --> 00:05:22,679 use the prices here 12 10 times the 118 00:05:19,600 --> 00:05:23,639 price of the car in 2012 is 24,000 119 00:05:22,680 --> 00:05:27,000 that's 120 00:05:23,639 --> 00:05:30,319 240 obviously for the base year nominal 121 00:05:27,000 --> 00:05:33,279 GDP is the same as real GDP and then 12 122 00:05:30,319 --> 00:05:36,560 13 is 13 not time 26,000 but times 123 00:05:33,279 --> 00:05:38,918 24,000 and we get that now in this 124 00:05:36,560 --> 00:05:42,120 particular example of only one e one 125 00:05:38,918 --> 00:05:43,839 good ER you can pick any any base year 126 00:05:42,120 --> 00:05:45,959 and you'll get exactly the same rate of 127 00:05:43,839 --> 00:05:47,478 growth of real output if you have 128 00:05:45,959 --> 00:05:49,079 multiple Goods that's not true because 129 00:05:47,478 --> 00:05:52,318 the relative prices of goods are moving 130 00:05:49,079 --> 00:05:55,399 over time okay but uh but that's the 131 00:05:52,319 --> 00:05:57,680 basic idea so I mean again you should 132 00:05:55,399 --> 00:05:59,120 know these things they're not going to 133 00:05:57,680 --> 00:06:01,100 be tremendously important in the quiz 134 00:05:59,120 --> 00:06:04,280 but they will show up in your quiz 135 00:06:01,100 --> 00:06:06,800 [Music] 136 00:06:04,279 --> 00:06:09,839 okay and then we went some some 137 00:06:06,800 --> 00:06:11,918 definitions the unemployment rate know 138 00:06:09,839 --> 00:06:14,478 being the number of unemployed over the 139 00:06:11,918 --> 00:06:18,918 labor force not population that's 140 00:06:14,478 --> 00:06:21,279 important H we talked about inflation 141 00:06:18,918 --> 00:06:22,879 rate as well that's the rate of change 142 00:06:21,279 --> 00:06:24,119 of prices and there are different prices 143 00:06:22,879 --> 00:06:26,800 in the economy one of them is the 144 00:06:24,120 --> 00:06:30,439 deflator the other one is CPI and so on 145 00:06:26,800 --> 00:06:32,759 so forth that's it so that was the first 146 00:06:30,439 --> 00:06:35,038 uh lecture relevant for the quiz any 147 00:06:32,759 --> 00:06:38,800 question about 148 00:06:35,038 --> 00:06:38,800 that good keep 149 00:06:39,279 --> 00:06:43,799 moving okay then we move to when then we 150 00:06:41,959 --> 00:06:46,638 began to really get serious because we 151 00:06:43,800 --> 00:06:49,439 began to construct sort of a foundation 152 00:06:46,639 --> 00:06:52,478 for the islm model okay and the first 153 00:06:49,439 --> 00:06:55,478 thing we did is we look at the Goods 154 00:06:52,478 --> 00:06:55,478 Market 155 00:06:55,879 --> 00:07:00,759 uh no and and what we did here is just 156 00:06:59,199 --> 00:07:03,960 was say we describ the different 157 00:07:00,759 --> 00:07:06,879 components of of aggregate demand and we 158 00:07:03,959 --> 00:07:08,478 said in this econ for for now at least 159 00:07:06,879 --> 00:07:10,720 we're going to make this economy close 160 00:07:08,478 --> 00:07:12,758 so we we remove exports and imports and 161 00:07:10,720 --> 00:07:15,240 for your quiz absolutely you not going 162 00:07:12,759 --> 00:07:18,439 to see anything about exports or Imports 163 00:07:15,240 --> 00:07:20,879 okay so this is your aggregate demand ER 164 00:07:18,439 --> 00:07:23,240 we wanted to build a little more so we 165 00:07:20,879 --> 00:07:25,160 had to have some behavioral assumptions 166 00:07:23,240 --> 00:07:26,560 H we made it initially very simple we 167 00:07:25,160 --> 00:07:28,639 assumed this was 168 00:07:26,560 --> 00:07:32,959 exogenous the Govern expension was 169 00:07:28,639 --> 00:07:35,038 exogenous taxes were also exogenous t h 170 00:07:32,959 --> 00:07:36,878 and the only behavioral equation we had 171 00:07:35,038 --> 00:07:38,918 was this consumption function we said 172 00:07:36,879 --> 00:07:42,360 consumption is increasing disposable 173 00:07:38,918 --> 00:07:44,318 income okay so and we we assume 174 00:07:42,360 --> 00:07:47,240 something linear like this disposable 175 00:07:44,319 --> 00:07:50,439 income is just income minus taxes and 176 00:07:47,240 --> 00:07:52,319 remember income remember from the from 177 00:07:50,439 --> 00:07:55,360 the alternative ways of measuring GDP 178 00:07:52,319 --> 00:07:57,840 income is the same as output no so when 179 00:07:55,360 --> 00:07:59,680 I say income because as is relevant for 180 00:07:57,839 --> 00:08:03,239 the consump consumer well but it's the 181 00:07:59,680 --> 00:08:05,360 same as output so that's was our 182 00:08:03,240 --> 00:08:07,360 consumption function it had an upward 183 00:08:05,360 --> 00:08:10,400 slope it was upward sloping because 184 00:08:07,360 --> 00:08:14,520 there's a marginal propensity to consume 185 00:08:10,399 --> 00:08:17,878 C1 H and then then a key Assumption of 186 00:08:14,519 --> 00:08:19,680 this part of the course is that that H 187 00:08:17,879 --> 00:08:22,840 output is aggregate demand determined 188 00:08:19,680 --> 00:08:24,959 prices were completely fixed H and and 189 00:08:22,839 --> 00:08:26,959 we said well but you know output is 190 00:08:24,959 --> 00:08:30,918 whatever demand wants that's what output 191 00:08:26,959 --> 00:08:33,399 is so this is an equilibrium condition 192 00:08:30,918 --> 00:08:35,399 okay this is the aggregate demand this 193 00:08:33,399 --> 00:08:37,120 is an equilibrium condition so we can 194 00:08:35,399 --> 00:08:40,038 solve out because I can say in 195 00:08:37,120 --> 00:08:41,799 equilibrium Z is equal to Y and I can 196 00:08:40,038 --> 00:08:43,759 solve for equilibrium output from that 197 00:08:41,799 --> 00:08:46,120 equation okay and that's exactly what we 198 00:08:43,759 --> 00:08:48,759 did in this slide and you got to an 199 00:08:46,120 --> 00:08:51,159 expression like this knowing how to do 200 00:08:48,759 --> 00:08:52,679 that is very important for you okay so 201 00:08:51,159 --> 00:08:56,719 you you better be sure that you know how 202 00:08:52,679 --> 00:08:58,759 to find equilibrium output in in in this 203 00:08:56,720 --> 00:09:00,639 model I mean it's going to be very 204 00:08:58,759 --> 00:09:03,759 difficult to do I M if you don't know 205 00:09:00,639 --> 00:09:06,958 these steps so so you better know this 206 00:09:03,759 --> 00:09:08,958 stuff H and remember something we call 207 00:09:06,958 --> 00:09:11,319 this guy here in the simple economy the 208 00:09:08,958 --> 00:09:13,000 multiplier why the multiplier well 209 00:09:11,320 --> 00:09:16,839 because given certain sort of something 210 00:09:13,000 --> 00:09:20,720 we call exogenous expenditure the 1 211 00:09:16,839 --> 00:09:23,480 minus C1 multiplies that if the marginal 212 00:09:20,720 --> 00:09:25,800 to consume is very high say it's close 213 00:09:23,480 --> 00:09:28,360 to one then the multipli is very very 214 00:09:25,799 --> 00:09:32,240 high if the marginal Pro to consume say 215 00:09:28,360 --> 00:09:32,240 is 05 then how much is the 216 00:09:33,480 --> 00:09:40,920 multiplier two okay good so the 217 00:09:36,639 --> 00:09:42,838 multiplier is two okay good and that was 218 00:09:40,919 --> 00:09:44,919 our equilibrium now we had the aggregate 219 00:09:42,839 --> 00:09:46,839 demand the slope was less than the 45 220 00:09:44,919 --> 00:09:48,838 degree line because C1 is a number less 221 00:09:46,839 --> 00:09:50,360 than one and so you have some 222 00:09:48,839 --> 00:09:52,480 equilibrium output there that's 223 00:09:50,360 --> 00:09:55,519 equilibrium output at this point 224 00:09:52,480 --> 00:09:57,200 aggregate demand is equal to well agre 225 00:09:55,519 --> 00:09:59,639 demand is equal to agre supply that's 226 00:09:57,200 --> 00:10:01,519 that's always true uh but that's 227 00:09:59,639 --> 00:10:03,480 consistent also with aggregate demand 228 00:10:01,519 --> 00:10:06,759 okay with the with the function of 229 00:10:03,480 --> 00:10:08,920 aggregate demand and and the important 230 00:10:06,759 --> 00:10:10,759 for for this equilibrium output is that 231 00:10:08,919 --> 00:10:11,958 that equilibrium output is a function of 232 00:10:10,759 --> 00:10:13,838 a lot of things that we took as 233 00:10:11,958 --> 00:10:16,078 parameters in this aggregate demand 234 00:10:13,839 --> 00:10:20,320 curve what did we take as parameters in 235 00:10:16,078 --> 00:10:20,319 the agregate bank care just give 236 00:10:22,480 --> 00:10:29,159 examples well investment government 237 00:10:26,320 --> 00:10:31,320 expenditure and taxes at the very least 238 00:10:29,159 --> 00:10:34,199 tax also parameters like autonomous 239 00:10:31,320 --> 00:10:36,839 consumption that c0 were taking as given 240 00:10:34,200 --> 00:10:38,360 anything if any of those things move 241 00:10:36,839 --> 00:10:40,360 this the position of this aggregate 242 00:10:38,360 --> 00:10:43,800 demand curve will shift 243 00:10:40,360 --> 00:10:46,000 around okay and that was one example 244 00:10:43,799 --> 00:10:48,000 suppose autonomous consumption C zero 245 00:10:46,000 --> 00:10:51,480 goes up so suddenly consumers decide to 246 00:10:48,000 --> 00:10:54,278 spend more okay well then then what we 247 00:10:51,480 --> 00:10:56,399 had is is that aggregate demand shift up 248 00:10:54,278 --> 00:10:59,000 and equilibrium output ends up changing 249 00:10:56,399 --> 00:10:59,839 by more than the initial change in c z 250 00:10:59,000 --> 00:11:02,600 why is 251 00:10:59,839 --> 00:11:04,160 that so this is the change in 252 00:11:02,600 --> 00:11:07,839 c0 253 00:11:04,159 --> 00:11:10,120 but uh but the change in output and so 254 00:11:07,839 --> 00:11:12,240 the initial change c0 leads to an 255 00:11:10,120 --> 00:11:15,320 initial change in output which is equal 256 00:11:12,240 --> 00:11:17,360 to c0 that's up to here but then we end 257 00:11:15,320 --> 00:11:20,200 up with final equilibrium output is is 258 00:11:17,360 --> 00:11:21,959 is higher than the initial response all 259 00:11:20,200 --> 00:11:26,519 this happens infinitely fast in this 260 00:11:21,958 --> 00:11:28,919 model why is this change greater than 261 00:11:26,519 --> 00:11:30,039 c0 there is a multiplier in front 262 00:11:28,919 --> 00:11:32,599 exactly 263 00:11:30,039 --> 00:11:34,879 we change c0 by one but then you have to 264 00:11:32,600 --> 00:11:37,200 multiply by 1/ 1 minus C1 and that's 265 00:11:34,879 --> 00:11:41,278 what we Illustrated in this picture 266 00:11:37,200 --> 00:11:43,240 there okay good and so you should move 267 00:11:41,278 --> 00:11:47,720 anything you you can move here around no 268 00:11:43,240 --> 00:11:50,120 move G up T up or stuff like that and 269 00:11:47,720 --> 00:11:52,278 see what 270 00:11:50,120 --> 00:11:54,560 happens the last thing I did in this 271 00:11:52,278 --> 00:11:56,639 section is is uh I show you an 272 00:11:54,559 --> 00:12:00,000 alternative way entirely equivalent way 273 00:11:56,639 --> 00:12:01,680 of of illustrating equilibrium which was 274 00:12:00,000 --> 00:12:05,320 saving equal to 275 00:12:01,679 --> 00:12:07,559 investment H remember and I derive 276 00:12:05,320 --> 00:12:08,879 this and I got to an expression like 277 00:12:07,559 --> 00:12:10,359 that that's exactly the same as 278 00:12:08,879 --> 00:12:13,759 aggregate demand equal to aggregate 279 00:12:10,360 --> 00:12:16,600 supply no a investment which in this 280 00:12:13,759 --> 00:12:18,159 particular basic model is fixed is equal 281 00:12:16,600 --> 00:12:19,720 to saving by the government which is 282 00:12:18,159 --> 00:12:23,198 also in this basic model is fixed 283 00:12:19,720 --> 00:12:26,720 because it's G minus t which is fixed H 284 00:12:23,198 --> 00:12:29,359 sorry it's T minus G which is fixed and 285 00:12:26,720 --> 00:12:32,879 then private saving and and then I show 286 00:12:29,360 --> 00:12:34,720 you a an interesting result which is 287 00:12:32,879 --> 00:12:37,000 called known the Paradox of savings 288 00:12:34,720 --> 00:12:40,079 which says the following if for whatever 289 00:12:37,000 --> 00:12:43,440 reason consumers decide to save more say 290 00:12:40,078 --> 00:12:46,078 for example because c z now comes down 291 00:12:43,440 --> 00:12:47,519 okay so now out they have certain income 292 00:12:46,078 --> 00:12:48,399 out of that same income they want to 293 00:12:47,519 --> 00:12:51,360 save 294 00:12:48,399 --> 00:12:56,000 more then from this very simple equation 295 00:12:51,360 --> 00:12:56,000 I know that what happens to Output 296 00:13:02,600 --> 00:13:07,480 why because savings go up consum Dem 297 00:13:06,000 --> 00:13:10,958 goes down and then also investment 298 00:13:07,480 --> 00:13:13,120 suppos to go down and then no investment 299 00:13:10,958 --> 00:13:17,039 doesn't go down here because it's fixed 300 00:13:13,120 --> 00:13:19,959 in this this B Bas basic example not 301 00:13:17,039 --> 00:13:21,719 islm yes but that's that's that's an 302 00:13:19,958 --> 00:13:24,078 explanation which is is the right 303 00:13:21,720 --> 00:13:26,120 explanation but it's is it's the 304 00:13:24,078 --> 00:13:29,559 explanation in the other space output 305 00:13:26,120 --> 00:13:31,480 and and and and the income 306 00:13:29,559 --> 00:13:33,799 I want it in the space of saving an 307 00:13:31,480 --> 00:13:35,800 investment so let me give it to you very 308 00:13:33,799 --> 00:13:37,879 quickly but your answer is correct but 309 00:13:35,799 --> 00:13:39,078 but but it's not what I wanted here 310 00:13:37,879 --> 00:13:41,399 because what I wanted to say is the 311 00:13:39,078 --> 00:13:44,039 following if for whatever reason for any 312 00:13:41,399 --> 00:13:46,240 given level of income savings go up then 313 00:13:44,039 --> 00:13:47,360 we have an imbalance saving total saving 314 00:13:46,240 --> 00:13:49,480 is greater than 315 00:13:47,360 --> 00:13:52,039 investment the only variable that can 316 00:13:49,480 --> 00:13:54,240 adjust here so we restore equilibrium 317 00:13:52,039 --> 00:13:55,958 investment equal to saving is for output 318 00:13:54,240 --> 00:13:57,839 to bring come down because if output 319 00:13:55,958 --> 00:14:00,159 comes down savings come down and that's 320 00:13:57,839 --> 00:14:01,920 the way you restore equilibrium 321 00:14:00,159 --> 00:14:03,799 I told you this way of looking at thing 322 00:14:01,919 --> 00:14:06,000 is entirely equivalent as we had already 323 00:14:03,799 --> 00:14:08,559 done so I can also do what you wanted to 324 00:14:06,000 --> 00:14:11,559 do which is represent that in the space 325 00:14:08,559 --> 00:14:15,879 of output and aggregate demand and and 326 00:14:11,559 --> 00:14:17,119 output or or income and and the an 327 00:14:15,879 --> 00:14:20,759 increase in 328 00:14:17,120 --> 00:14:22,278 c0 a reduction in c0 would lead to a 329 00:14:20,759 --> 00:14:24,039 decline in aggregate demand and then 330 00:14:22,278 --> 00:14:25,799 through the multiply larger increase in 331 00:14:24,039 --> 00:14:28,360 output so this is the way we characteriz 332 00:14:25,799 --> 00:14:30,958 it before this is a slightly different 333 00:14:28,360 --> 00:14:32,240 way of of characterizing which is is 334 00:14:30,958 --> 00:14:33,919 what gives rise to what is called the 335 00:14:32,240 --> 00:14:36,360 Paradox of saving because suddenly you 336 00:14:33,919 --> 00:14:37,679 decide to save more supposed to be good 337 00:14:36,360 --> 00:14:42,039 well in the short run it's not really 338 00:14:37,679 --> 00:14:43,638 good it causes a recession okay anyway 339 00:14:42,039 --> 00:14:48,599 it's cute but it may show up in your 340 00:14:43,639 --> 00:14:48,600 future so I wanted to remind you 341 00:15:01,639 --> 00:15:07,639 so that was the Goods Market side 342 00:15:05,078 --> 00:15:09,599 oops then we look at financial markets 343 00:15:07,639 --> 00:15:11,320 and we we trivialized financial markets 344 00:15:09,600 --> 00:15:13,480 really we said let's assume the 345 00:15:11,320 --> 00:15:19,759 financial markets are very very simple 346 00:15:13,480 --> 00:15:19,759 money and bonds that's it nothing else 347 00:15:20,000 --> 00:15:25,198 ER and the first sort of behavior the 348 00:15:23,639 --> 00:15:27,278 the only behavioral equation we really 349 00:15:25,198 --> 00:15:29,159 had here was money demand and we say 350 00:15:27,278 --> 00:15:31,639 well money demand is increasing in nomal 351 00:15:29,159 --> 00:15:33,240 GDP because if nominal GDP is larger 352 00:15:31,639 --> 00:15:37,159 then you need to do more transactions 353 00:15:33,240 --> 00:15:39,480 you need more money more cash ER cash or 354 00:15:37,159 --> 00:15:41,879 deposit but here we're looking only at 355 00:15:39,480 --> 00:15:43,879 cash but it's decreasing in the interest 356 00:15:41,879 --> 00:15:45,559 rate money money is decreasing the Reon 357 00:15:43,879 --> 00:15:48,159 why it's decreasing in interest rate 358 00:15:45,559 --> 00:15:50,599 interest rate is the return on the bonds 359 00:15:48,159 --> 00:15:52,919 no why is money demand decreasing in the 360 00:15:50,600 --> 00:15:52,920 interest 361 00:15:55,039 --> 00:15:59,599 rate yeah the opportunity cost of 362 00:15:57,240 --> 00:16:02,198 holding cash in your pocket is higher 363 00:15:59,600 --> 00:16:06,240 you didn't care about this 364 00:16:02,198 --> 00:16:09,519 stuff you know a year ago but now you 365 00:16:06,240 --> 00:16:13,360 know it cost you 5% to hold cash that's 366 00:16:09,519 --> 00:16:16,078 what you get in a in a one year 367 00:16:13,360 --> 00:16:18,639 certificate Bond you treasury bond at 368 00:16:16,078 --> 00:16:20,078 this moment so it's more significant 369 00:16:18,639 --> 00:16:22,198 maybe it's not that relevant for you but 370 00:16:20,078 --> 00:16:23,439 Corporation makes a big difference I 371 00:16:22,198 --> 00:16:24,958 guarantee you right than keeping the 372 00:16:23,440 --> 00:16:26,720 thing in the checking account now 373 00:16:24,958 --> 00:16:29,799 they're really buying short-term 374 00:16:26,720 --> 00:16:33,319 treasuries and stuff like that okay 375 00:16:29,799 --> 00:16:37,159 um good so so that's the reason this is 376 00:16:33,318 --> 00:16:40,879 downward sloping um and 377 00:16:37,159 --> 00:16:43,958 uh and that's the concept here so then 378 00:16:40,879 --> 00:16:45,679 what the Central Bank controls is money 379 00:16:43,958 --> 00:16:48,919 how much money it injects in the economy 380 00:16:45,679 --> 00:16:50,638 that is how much H you know when okay 381 00:16:48,919 --> 00:16:53,838 how much money it injects into the 382 00:16:50,639 --> 00:16:56,759 economy how does let me say just that 383 00:16:53,839 --> 00:16:58,959 for now and so that's like money supply 384 00:16:56,759 --> 00:17:01,919 so the equilibrium interest rate is 385 00:16:58,958 --> 00:17:03,638 simply uh the point in which money 386 00:17:01,919 --> 00:17:06,318 demand is equal to the money exogenous 387 00:17:03,639 --> 00:17:08,519 money supply and I said in the modern 388 00:17:06,318 --> 00:17:10,480 world the central banks don't tell you 389 00:17:08,519 --> 00:17:12,119 Ms they tell you this is the interest 390 00:17:10,480 --> 00:17:15,640 rate we want and then they provide 391 00:17:12,119 --> 00:17:17,479 whatever M they need in order to get the 392 00:17:15,640 --> 00:17:20,759 interest rate they have told you that 393 00:17:17,480 --> 00:17:23,038 the they want to have okay so that's the 394 00:17:20,759 --> 00:17:24,558 case of an expansionary monetary policy 395 00:17:23,038 --> 00:17:26,759 suppose the FED wants to lower the 396 00:17:24,558 --> 00:17:30,000 interest rate from here to here well 397 00:17:26,759 --> 00:17:32,720 what it needs to do is increase money 398 00:17:30,000 --> 00:17:36,558 and increase money means it goes out 399 00:17:32,720 --> 00:17:38,839 there and open market operation and and 400 00:17:36,558 --> 00:17:42,240 and the buys bonds from the private 401 00:17:38,839 --> 00:17:46,439 sector okay buys bonds takes Bonds in 402 00:17:42,240 --> 00:17:47,880 and gives them Cash Money okay that's an 403 00:17:46,440 --> 00:17:50,000 expansion in monetary policy an 404 00:17:47,880 --> 00:17:52,559 expansionary monetary policy will lower 405 00:17:50,000 --> 00:17:52,558 the interest 406 00:17:53,240 --> 00:17:58,640 rate that's an open market operation so 407 00:17:55,880 --> 00:18:00,200 that's what we just saw was exactly that 408 00:17:58,640 --> 00:18:02,600 the the FED wants to lower the interest 409 00:18:00,200 --> 00:18:04,558 rate what it does is it goes out there 410 00:18:02,599 --> 00:18:06,199 it buys bonds from the private sector so 411 00:18:04,558 --> 00:18:08,720 it's balance sheet on the asset side has 412 00:18:06,200 --> 00:18:10,400 more bonds now but it has more 413 00:18:08,720 --> 00:18:11,600 liabilities because it gives cash to 414 00:18:10,400 --> 00:18:14,280 people and that's the liability of the 415 00:18:11,599 --> 00:18:15,879 central banks okay so that's that's an 416 00:18:14,279 --> 00:18:18,319 open market operation that's an 417 00:18:15,880 --> 00:18:22,320 expansionary open market operation which 418 00:18:18,319 --> 00:18:24,599 is designed to lower the interest rate 419 00:18:22,319 --> 00:18:25,918 okay then I talked about the 420 00:18:24,599 --> 00:18:28,918 relationship between the interest rate 421 00:18:25,919 --> 00:18:31,440 and the price of the bond okay and 422 00:18:28,919 --> 00:18:34,480 that's that's a return on a bond no is 423 00:18:31,440 --> 00:18:37,679 is is the face value of the bond what 424 00:18:34,480 --> 00:18:40,440 you get in when the bond matures say 425 00:18:37,679 --> 00:18:43,320 it's 100 it's a B for 100 minus whatever 426 00:18:40,440 --> 00:18:47,000 you pay divided by whatever you pay so 427 00:18:43,319 --> 00:18:49,158 say if you pay today $95 for a bond that 428 00:18:47,000 --> 00:18:52,279 will pay you $100 a year from now that's 429 00:18:49,159 --> 00:18:55,520 approximately a 5% interest rate no it's 430 00:18:52,279 --> 00:18:58,960 a little more but but that's about it 431 00:18:55,519 --> 00:19:00,519 okay H which is also helps in the 432 00:18:58,960 --> 00:19:02,720 understand a little bit what what what 433 00:19:00,519 --> 00:19:04,558 happens during an open market operation 434 00:19:02,720 --> 00:19:06,400 in an open market operation an expansion 435 00:19:04,558 --> 00:19:08,000 in monetary policy the Central Bank goes 436 00:19:06,400 --> 00:19:11,159 out there and buys 437 00:19:08,000 --> 00:19:13,359 bonds what typically happens to a price 438 00:19:11,159 --> 00:19:16,120 of a good that is a good or an asset 439 00:19:13,359 --> 00:19:19,199 that is been bought by somebody big that 440 00:19:16,119 --> 00:19:20,759 has goes up or down now we have a big 441 00:19:19,200 --> 00:19:22,080 buyer out there that goes and buys Bond 442 00:19:20,759 --> 00:19:23,759 do you think the price of bonds will go 443 00:19:22,079 --> 00:19:27,759 up or 444 00:19:23,759 --> 00:19:29,400 down up no big guy buyer got into the 445 00:19:27,759 --> 00:19:32,038 market to buy bonds the price of bonds 446 00:19:29,400 --> 00:19:34,840 go up but if the P price of bonds goes 447 00:19:32,038 --> 00:19:37,400 up that means the interest rate goes 448 00:19:34,839 --> 00:19:38,798 down that's an intuitive way of 449 00:19:37,400 --> 00:19:41,038 understanding how monetary policy lowers 450 00:19:38,798 --> 00:19:43,240 interest rate it's a big buyer buying 451 00:19:41,038 --> 00:19:44,919 bonds the price of bonds will go up but 452 00:19:43,240 --> 00:19:47,880 the interest rate and the price of the 453 00:19:44,919 --> 00:19:47,880 bond are inversely 454 00:19:48,599 --> 00:19:52,839 related you you can see that now suppose 455 00:19:51,000 --> 00:19:55,599 that the initial price of the bond was 456 00:19:52,839 --> 00:19:57,839 95 and now the price of the bone goes to 457 00:19:55,599 --> 00:19:59,678 100 the interest rate goes from a little 458 00:19:57,839 --> 00:20:02,038 more than 5% to 459 00:19:59,679 --> 00:20:05,919 zero 460 00:20:02,038 --> 00:20:08,558 good then I we talk about intermediaries 461 00:20:05,919 --> 00:20:08,559 forget it for 462 00:20:09,038 --> 00:20:14,158 now so then we got into two lectures 463 00:20:11,519 --> 00:20:16,759 about the islm about the basic islm 464 00:20:14,159 --> 00:20:19,400 model and then we did one more on on the 465 00:20:16,759 --> 00:20:21,519 extended islm model and I told you that 466 00:20:19,400 --> 00:20:25,120 at least two third of your quiz will be 467 00:20:21,519 --> 00:20:26,639 about this so and and I I I already know 468 00:20:25,119 --> 00:20:29,239 what is in the quiz and I guarantee you 469 00:20:26,640 --> 00:20:31,559 that I honor my my 470 00:20:29,240 --> 00:20:35,000 commitment okay so so you better 471 00:20:31,558 --> 00:20:37,319 understand the slm mod very very well 472 00:20:35,000 --> 00:20:39,038 now understanding the slm mod also me 473 00:20:37,319 --> 00:20:42,519 understanding the previous two lectures 474 00:20:39,038 --> 00:20:45,519 because we're building the islm model 475 00:20:42,519 --> 00:20:45,519 there 476 00:20:46,519 --> 00:20:50,480 ER so the first thing we did here is 477 00:20:49,119 --> 00:20:52,759 said well to make this stuff a little 478 00:20:50,480 --> 00:20:54,360 more interest we already had a model in 479 00:20:52,759 --> 00:20:58,319 which we could find equilibrium output 480 00:20:54,359 --> 00:21:00,879 remember that was in in lecture three we 481 00:20:58,319 --> 00:21:02,759 had that that but we said but but we 482 00:21:00,880 --> 00:21:04,720 took many things as exogenous there that 483 00:21:02,759 --> 00:21:06,839 are really not exogenous in practice in 484 00:21:04,720 --> 00:21:09,038 particular private investment private 485 00:21:06,839 --> 00:21:11,278 investment certainly something that 486 00:21:09,038 --> 00:21:13,079 responds to aggregate activity and to 487 00:21:11,278 --> 00:21:15,400 the cost of borrowing and things of that 488 00:21:13,079 --> 00:21:18,119 nature so what we did the first thing we 489 00:21:15,400 --> 00:21:20,320 did here is we we changed the investment 490 00:21:18,119 --> 00:21:22,119 function for some constant for something 491 00:21:20,319 --> 00:21:25,240 that was a function of output and the 492 00:21:22,119 --> 00:21:26,519 interest rate that component here this 493 00:21:25,240 --> 00:21:28,679 this the fact that was increasing in 494 00:21:26,519 --> 00:21:30,759 output just increased the multiplier but 495 00:21:28,679 --> 00:21:33,320 it didn't change anything 496 00:21:30,759 --> 00:21:34,599 qualitatively in the analysis but the 497 00:21:33,319 --> 00:21:38,319 fact that it depends on the interest 498 00:21:34,599 --> 00:21:40,719 rate is important because now we have as 499 00:21:38,319 --> 00:21:42,079 a parameter in the in in the goods Mar 500 00:21:40,720 --> 00:21:45,159 in the aggregate demand curve the 501 00:21:42,079 --> 00:21:47,000 interest rate okay when you solve out 502 00:21:45,159 --> 00:21:48,278 the whole thing the interest rate is one 503 00:21:47,000 --> 00:21:50,480 of the things that can move agregate 504 00:21:48,278 --> 00:21:52,319 demand around and and and that's 505 00:21:50,480 --> 00:21:53,599 important because now you can begin to 506 00:21:52,319 --> 00:21:55,798 see the connection between what the 507 00:21:53,599 --> 00:21:57,678 Central Bank does and how it affects 508 00:21:55,798 --> 00:21:59,400 aggregate activity because what the 509 00:21:57,679 --> 00:22:01,278 Central Bank does affect the interest 510 00:21:59,400 --> 00:22:03,640 rate the Central Bank cannot go out 511 00:22:01,278 --> 00:22:05,919 there and buy hamburgers as I said it 512 00:22:03,640 --> 00:22:08,080 can go out there and buy bonds and with 513 00:22:05,919 --> 00:22:10,278 that it affects the interest rate and 514 00:22:08,079 --> 00:22:12,599 and for that to matter for the economy 515 00:22:10,278 --> 00:22:14,359 not only to bond holders it better be 516 00:22:12,599 --> 00:22:16,359 the case that that interest rate matters 517 00:22:14,359 --> 00:22:19,839 for the equilibrium level of output and 518 00:22:16,359 --> 00:22:21,719 it does so by affecting real investment 519 00:22:19,839 --> 00:22:25,158 okay so that's a mechanism through which 520 00:22:21,720 --> 00:22:27,278 monetary policy affect real activity is 521 00:22:25,159 --> 00:22:29,960 through the cost of 522 00:22:27,278 --> 00:22:32,200 borrowing we simply in in in reality 523 00:22:29,960 --> 00:22:34,319 consumers are also affected by that by 524 00:22:32,200 --> 00:22:36,798 interest rate and so on but the but 525 00:22:34,319 --> 00:22:38,918 let's keep things simple and have only 526 00:22:36,798 --> 00:22:41,278 investment as a function of the interest 527 00:22:38,919 --> 00:22:43,320 rate and and very importantly it's a 528 00:22:41,278 --> 00:22:45,079 decreasing function of the interest rate 529 00:22:43,319 --> 00:22:46,839 the higher interest rates the lower is 530 00:22:45,079 --> 00:22:49,240 investment for any given of output 531 00:22:46,839 --> 00:22:51,720 because it's more costly to borrow to 532 00:22:49,240 --> 00:22:55,359 fund that investment so that gave us our 533 00:22:51,720 --> 00:22:57,159 a curve which is a the combinations of 534 00:22:55,359 --> 00:22:58,719 output and interest rate that are 535 00:22:57,159 --> 00:23:00,400 consistent with equilibrium in the 536 00:22:58,720 --> 00:23:02,759 Market that is when output is equal to 537 00:23:00,400 --> 00:23:06,038 aggregate demand 538 00:23:02,759 --> 00:23:11,000 okay so I say yes so that point belongs 539 00:23:06,038 --> 00:23:14,759 to one is for one interest rate here 540 00:23:11,000 --> 00:23:18,440 okay so how do we construct the is well 541 00:23:14,759 --> 00:23:20,278 we start moving the interest rate no so 542 00:23:18,440 --> 00:23:22,278 uh suppose we start from this this is 543 00:23:20,278 --> 00:23:24,519 one point in the the point I just showed 544 00:23:22,278 --> 00:23:27,079 you supposing that we now we increase 545 00:23:24,519 --> 00:23:29,158 the interest rate we look at the new 546 00:23:27,079 --> 00:23:31,399 equilibrium output well that Al belongs 547 00:23:29,159 --> 00:23:33,240 to this is okay and you can keep moving 548 00:23:31,400 --> 00:23:34,919 the interest rate around so you move ZZ 549 00:23:33,240 --> 00:23:37,519 around only by moving the interest rate 550 00:23:34,919 --> 00:23:39,080 don't move g t anything else only by 551 00:23:37,519 --> 00:23:43,319 moving the interest rate and then you 552 00:23:39,079 --> 00:23:45,119 can trace an is curve okay if you move 553 00:23:43,319 --> 00:23:46,720 other parameter than the interest rate 554 00:23:45,119 --> 00:23:48,278 then it's a move it's a shift in the 555 00:23:46,720 --> 00:23:51,640 curve it's not a movement along the 556 00:23:48,278 --> 00:23:53,839 curve so if for example if I increase G 557 00:23:51,640 --> 00:23:53,840 what 558 00:23:54,200 --> 00:24:00,360 happens with this 559 00:23:57,000 --> 00:24:02,319 curve the curve shift to the right okay 560 00:24:00,359 --> 00:24:05,079 because now for any given level of 561 00:24:02,319 --> 00:24:07,399 interest rate output will be higher 562 00:24:05,079 --> 00:24:11,079 because aggregate demand moves up and so 563 00:24:07,400 --> 00:24:13,400 that's a shift to the right of theare 564 00:24:11,079 --> 00:24:15,439 good that's an example of the opposite 565 00:24:13,400 --> 00:24:19,038 is an increasing taxes well it will 566 00:24:15,440 --> 00:24:19,038 shift the yes to the 567 00:24:21,038 --> 00:24:25,839 left the L relationship is we already 568 00:24:23,960 --> 00:24:28,600 described it is is no equilibrium in 569 00:24:25,839 --> 00:24:31,278 financial markets but we said the way 570 00:24:28,599 --> 00:24:33,240 monetary policies conducted is the Fed 571 00:24:31,278 --> 00:24:35,440 sets the interest rate and then money is 572 00:24:33,240 --> 00:24:37,720 whatever the market needs in order for 573 00:24:35,440 --> 00:24:41,159 that to be the equilibrium interest rate 574 00:24:37,720 --> 00:24:43,798 so the mod LM if you will is horizontal 575 00:24:41,159 --> 00:24:45,799 it's like that okay so now we're set 576 00:24:43,798 --> 00:24:48,599 because once the FED decides to set this 577 00:24:45,798 --> 00:24:50,200 interest rate we can find not only the 578 00:24:48,599 --> 00:24:51,599 equilibrium combinations of interest 579 00:24:50,200 --> 00:24:53,919 rate and output that are consistent with 580 00:24:51,599 --> 00:24:56,079 equilibrium in the Goods Market but the 581 00:24:53,919 --> 00:24:58,120 particular equilibrium level of output 582 00:24:56,079 --> 00:24:59,398 that is consistent with that interest 583 00:24:58,119 --> 00:25:01,918 rate 584 00:24:59,398 --> 00:25:05,479 and that's exactly equilibrium out okay 585 00:25:01,919 --> 00:25:07,600 so given the LM now I looked at 586 00:25:05,480 --> 00:25:09,319 intersection with my is and that gives 587 00:25:07,599 --> 00:25:10,759 me equilibrium output for that level of 588 00:25:09,319 --> 00:25:14,038 the interest rate which has been set by 589 00:25:10,759 --> 00:25:14,038 the FED 590 00:25:14,839 --> 00:25:19,119 okay and then you can use this model 591 00:25:17,038 --> 00:25:20,960 this is a very powerful little model 592 00:25:19,119 --> 00:25:24,038 because now you can do lots of things 593 00:25:20,960 --> 00:25:25,960 with it no for example H that's a 594 00:25:24,038 --> 00:25:28,359 contractionary fiscal policy that's what 595 00:25:25,960 --> 00:25:31,079 happens when you reduce G or when you 596 00:25:28,359 --> 00:25:31,079 you increase 597 00:25:33,038 --> 00:25:42,119 T what happens if you reduce 598 00:25:37,480 --> 00:25:42,120 G and T by the same 599 00:25:44,919 --> 00:25:50,120 amount you see what I'm doing and maybe 600 00:25:48,079 --> 00:25:51,480 if you that that's often done is okay 601 00:25:50,119 --> 00:25:53,599 you can increase govern expend but then 602 00:25:51,480 --> 00:25:56,440 you find a source of Revenue or or or 603 00:25:53,599 --> 00:25:58,599 reduced govern expenditure but 604 00:25:56,440 --> 00:26:00,759 then you don't need to generate fiscal 605 00:25:58,599 --> 00:26:01,519 Surplus so on so when I'm saying this is 606 00:26:00,759 --> 00:26:04,319 a 607 00:26:01,519 --> 00:26:06,398 Balan Balan budget fiscal policy that's 608 00:26:04,319 --> 00:26:11,079 what it's called okay what if I move G 609 00:26:06,398 --> 00:26:11,079 and T by the same amount does that curve 610 00:26:14,000 --> 00:26:20,119 move 611 00:26:16,440 --> 00:26:22,960 yeah because the multip next to T is c0 612 00:26:20,119 --> 00:26:29,038 in the equation original equation so 613 00:26:22,960 --> 00:26:32,960 c0 C1 okay perfect yeah yeah so in which 614 00:26:29,038 --> 00:26:37,278 direction does it move so if I reduce 615 00:26:32,960 --> 00:26:39,720 G and reduce T by the same amount what 616 00:26:37,278 --> 00:26:41,000 happens to the I moves to the left or to 617 00:26:39,720 --> 00:26:43,720 the 618 00:26:41,000 --> 00:26:45,798 right yeah it moves to the left left 619 00:26:43,720 --> 00:26:48,558 because why is that I can always go back 620 00:26:45,798 --> 00:26:50,879 to my basic Goods market equilibrium mod 621 00:26:48,558 --> 00:26:53,200 if I reduce G by one that reduces 622 00:26:50,880 --> 00:26:55,760 aggregate demand one by one one for one 623 00:26:53,200 --> 00:26:58,360 and then the multiplier sort of kicks in 624 00:26:55,759 --> 00:27:03,119 if I REM but the initial change shift 625 00:26:58,359 --> 00:27:06,558 down is one if I if I reduce 626 00:27:03,119 --> 00:27:11,959 taxes I increase aggregate demand but by 627 00:27:06,558 --> 00:27:14,879 C1 times one no and so I had a reduction 628 00:27:11,960 --> 00:27:18,200 in a demand of one and I had an increas 629 00:27:14,880 --> 00:27:20,159 in aggre demand of C1 1 minus C1 is 630 00:27:18,200 --> 00:27:26,640 greater than zero that's the reason you 631 00:27:20,159 --> 00:27:26,640 have a net a reduction in in agre demand 632 00:27:29,278 --> 00:27:37,599 hint this is not a random thought I have 633 00:27:32,038 --> 00:27:37,599 okay so so do understand it okay 634 00:27:39,038 --> 00:27:42,038 good 635 00:27:43,960 --> 00:27:51,679 okay that's monetary 636 00:27:46,200 --> 00:27:55,000 policy ER so um we that's an expansion 637 00:27:51,679 --> 00:27:57,559 in monetary policy and in equilibrium 638 00:27:55,000 --> 00:27:58,919 why is spary so cutting interest rate 639 00:27:57,558 --> 00:28:01,079 course it will increase equilibrium 640 00:27:58,919 --> 00:28:03,519 output that's a case in 641 00:28:01,079 --> 00:28:04,960 which the FED probably is unhappy with 642 00:28:03,519 --> 00:28:07,200 this low level of output maybe it's a 643 00:28:04,960 --> 00:28:08,880 recession so one of the main policy 644 00:28:07,200 --> 00:28:10,798 tools we have to fight a recession is to 645 00:28:08,880 --> 00:28:12,760 lower the interest rate and you can see 646 00:28:10,798 --> 00:28:15,158 here how lowering the interest rate will 647 00:28:12,759 --> 00:28:17,558 increase equilibrium output how does it 648 00:28:15,159 --> 00:28:20,559 happen why is it that this happen why is 649 00:28:17,558 --> 00:28:20,558 it that equilibrium output 650 00:28:22,640 --> 00:28:27,799 Rises exactly it's because increasing 651 00:28:25,398 --> 00:28:30,518 investment that gives us the first kick 652 00:28:27,798 --> 00:28:32,240 and once equilibrium starts Rising then 653 00:28:30,519 --> 00:28:33,839 consumption Rises and we get the whole 654 00:28:32,240 --> 00:28:36,399 the whole multiply but the initial 655 00:28:33,839 --> 00:28:39,398 impulse is exactly because there 656 00:28:36,398 --> 00:28:39,398 increase in in in 657 00:28:39,919 --> 00:28:44,840 investment H how does it Implement that 658 00:28:43,079 --> 00:28:46,398 open market operation so what the FED 659 00:28:44,839 --> 00:28:49,199 will do if it wants to cut the interest 660 00:28:46,398 --> 00:28:52,678 rate it goes out there buys bonds from 661 00:28:49,200 --> 00:28:56,319 the public and gives him money in 662 00:28:52,679 --> 00:28:58,720 exchange okay and that's what happens 663 00:28:56,319 --> 00:29:00,599 here and then I talk about different 664 00:28:58,720 --> 00:29:02,440 policy mixes no this this is what 665 00:29:00,599 --> 00:29:05,079 typically when an economy is deep into 666 00:29:02,440 --> 00:29:06,720 recession you're going to see both 667 00:29:05,079 --> 00:29:08,319 policies that work at the same time 668 00:29:06,720 --> 00:29:10,480 that's very powerful that's a case in 669 00:29:08,319 --> 00:29:14,158 which in 670 00:29:10,480 --> 00:29:15,640 which you know we have a very we cut we 671 00:29:14,159 --> 00:29:17,519 have an expansionary monetary policy 672 00:29:15,640 --> 00:29:20,399 that shift is down and an expansionary 673 00:29:17,519 --> 00:29:22,399 fiscal policy and uh you know that's 674 00:29:20,398 --> 00:29:24,518 definitely what we did during covid was 675 00:29:22,398 --> 00:29:26,719 massive and during the global financial 676 00:29:24,519 --> 00:29:29,278 crisis so typically big recessions will 677 00:29:26,720 --> 00:29:30,880 lead to any recession will lead to 678 00:29:29,278 --> 00:29:32,319 something like that obviously if it is 679 00:29:30,880 --> 00:29:35,120 Big you're going to have to a bigger 680 00:29:32,319 --> 00:29:37,759 combination of this kind of 681 00:29:35,119 --> 00:29:40,038 stuff some problems that that monetary 682 00:29:37,759 --> 00:29:42,480 policy May face is that you know 683 00:29:40,038 --> 00:29:43,919 sometimes you hit a Zer lower bound and 684 00:29:42,480 --> 00:29:45,319 then when you hit a zero lower bound is 685 00:29:43,919 --> 00:29:47,640 you just can't lower the interest rate 686 00:29:45,319 --> 00:29:49,519 more you lose monetary policy you need 687 00:29:47,640 --> 00:29:52,759 to do other stuff and typically fiscal 688 00:29:49,519 --> 00:29:55,038 policy then becomes very very active 689 00:29:52,759 --> 00:29:57,000 okay and this is not just a the 690 00:29:55,038 --> 00:30:00,038 theoretical curiosity I mean we have 691 00:29:57,000 --> 00:30:02,919 been against zero lower Bound for a 692 00:30:00,038 --> 00:30:05,720 sustain amount of time during the last 693 00:30:02,919 --> 00:30:05,720 20 years or 694 00:30:06,440 --> 00:30:12,360 so oh that's another policy mix as well 695 00:30:10,398 --> 00:30:15,038 that suppose that you need to do a 696 00:30:12,359 --> 00:30:18,398 fiscal adjustment I said so you want to 697 00:30:15,038 --> 00:30:20,278 reduce the deficit reduce G but you 698 00:30:18,398 --> 00:30:22,759 don't want to have a recession as a 699 00:30:20,278 --> 00:30:25,319 result of that one way you can do that 700 00:30:22,759 --> 00:30:27,960 is by you know you have a a contraction 701 00:30:25,319 --> 00:30:29,960 in G or increase in taxes that's contra 702 00:30:27,960 --> 00:30:32,000 actionary but you can offset it with an 703 00:30:29,960 --> 00:30:33,600 expansion in monetary policy I think in 704 00:30:32,000 --> 00:30:35,759 the quiz somewhere you have a question 705 00:30:33,599 --> 00:30:37,599 not I don't think there specific to this 706 00:30:35,759 --> 00:30:38,919 but in which you're asked to compensate 707 00:30:37,599 --> 00:30:41,398 for something with something and 708 00:30:38,919 --> 00:30:44,480 something like that okay so some curve 709 00:30:41,398 --> 00:30:47,839 move and then you are asked to offset 710 00:30:44,480 --> 00:30:49,839 that effect on output okay so you should 711 00:30:47,839 --> 00:30:53,240 understand these kind of things The Next 712 00:30:49,839 --> 00:30:57,678 Step was to extend a little bit our eslm 713 00:30:53,240 --> 00:31:01,519 model and by extension we said well look 714 00:30:57,679 --> 00:31:04,399 at this moment we have only a um prices 715 00:31:01,519 --> 00:31:06,399 are completely fixed but in reality we 716 00:31:04,398 --> 00:31:08,199 have inflation and so the nominal 717 00:31:06,398 --> 00:31:09,918 interest rate is not really the 718 00:31:08,200 --> 00:31:11,960 effective cost of capital for a company 719 00:31:09,919 --> 00:31:14,000 a company that wants to fund a real 720 00:31:11,960 --> 00:31:15,399 investment is more concerned with the 721 00:31:14,000 --> 00:31:17,440 real interest rate is pain not the 722 00:31:15,398 --> 00:31:19,839 nominal interest rate so with prices 723 00:31:17,440 --> 00:31:21,880 that are constant There's no distinction 724 00:31:19,839 --> 00:31:23,879 but if you have positive inflation then 725 00:31:21,880 --> 00:31:25,559 then then the distinction makes a makes 726 00:31:23,880 --> 00:31:27,360 a difference that's the reason we wanted 727 00:31:25,558 --> 00:31:30,319 to talk about that and the second thing 728 00:31:27,359 --> 00:31:32,000 is that the same firms are are very 729 00:31:30,319 --> 00:31:35,398 unlikely to pay the same that the 730 00:31:32,000 --> 00:31:37,519 treasury pays for borrowing pay it's a 731 00:31:35,398 --> 00:31:39,518 risky proposition to invest in bonds 732 00:31:37,519 --> 00:31:40,519 issued by a corporation and therefore 733 00:31:39,519 --> 00:31:43,278 they're going to have to pay a risk 734 00:31:40,519 --> 00:31:47,638 premium for that okay and so the 735 00:31:43,278 --> 00:31:49,960 importance of these two things is that 736 00:31:47,638 --> 00:31:53,359 ER we ended 737 00:31:49,960 --> 00:31:55,600 up with an islm M that have now had 738 00:31:53,359 --> 00:31:57,278 something a little more complicated here 739 00:31:55,599 --> 00:31:59,719 because it didn't have only the nominal 740 00:31:57,278 --> 00:32:02,519 interest rate but also had expected 741 00:31:59,720 --> 00:32:06,120 inflation if for any given nominal 742 00:32:02,519 --> 00:32:07,880 interest rate if if uh we expect a 743 00:32:06,119 --> 00:32:12,000 higher inflation that means a lower real 744 00:32:07,880 --> 00:32:13,559 interest rate okay so so for any given 745 00:32:12,000 --> 00:32:15,558 nominal interest rate if expected 746 00:32:13,558 --> 00:32:17,759 inflation goes up that's expansionary 747 00:32:15,558 --> 00:32:20,599 really for firms okay it's like it's 748 00:32:17,759 --> 00:32:23,278 cheaper in a sense to borrow okay 749 00:32:20,599 --> 00:32:25,879 conversely if x goes up the great spread 750 00:32:23,278 --> 00:32:27,599 goes up that's contractionary because 751 00:32:25,880 --> 00:32:32,880 it's now more expensive for the firms to 752 00:32:27,599 --> 00:32:38,759 borrow for any given real interest rate 753 00:32:32,880 --> 00:32:41,440 okay so we can we can this is called 754 00:32:38,759 --> 00:32:43,879 extended islm model simply because it 755 00:32:41,440 --> 00:32:47,120 has been extended to incorporate this 756 00:32:43,880 --> 00:32:49,120 these add additional factors and now you 757 00:32:47,119 --> 00:32:51,038 have two more parameters in your in your 758 00:32:49,119 --> 00:32:55,038 model which is expected inflation and 759 00:32:51,038 --> 00:32:56,480 the credit spreads okay so if you move 760 00:32:55,038 --> 00:32:58,839 either of 761 00:32:56,480 --> 00:33:00,278 these you're going to going to move your 762 00:32:58,839 --> 00:33:03,278 aggregate demand curve in the Goods 763 00:33:00,278 --> 00:33:05,159 Market no and it's going to move for 764 00:33:03,278 --> 00:33:07,278 exactly the same reasons that that 765 00:33:05,159 --> 00:33:10,240 aggregate demand move when you move the 766 00:33:07,278 --> 00:33:12,960 interest rate it enters symmetrically in 767 00:33:10,240 --> 00:33:14,759 this model these guys here enter 768 00:33:12,960 --> 00:33:17,240 completely symmetrically with then the 769 00:33:14,759 --> 00:33:18,960 interest rate so whatever was the 770 00:33:17,240 --> 00:33:21,319 comparative Statics you had with respect 771 00:33:18,960 --> 00:33:25,558 to the nominal interest rate before they 772 00:33:21,319 --> 00:33:28,439 appli to x minus 773 00:33:25,558 --> 00:33:31,599 Pi what I'm trying to say is 774 00:33:28,440 --> 00:33:34,240 if I if you know how what is the change 775 00:33:31,599 --> 00:33:35,918 in equilibrium output as a response as a 776 00:33:34,240 --> 00:33:38,159 result of an increase in 100 basis 777 00:33:35,919 --> 00:33:39,519 points on the nominal interest rate then 778 00:33:38,159 --> 00:33:41,360 you know what is a response of 779 00:33:39,519 --> 00:33:44,000 equilibrium output to an increasing 780 00:33:41,359 --> 00:33:46,798 credit spreads of 100 basis points or to 781 00:33:44,000 --> 00:33:49,000 a reduction or or to a reduction in 782 00:33:46,798 --> 00:33:50,119 expected inflation of 100 basis points 783 00:33:49,000 --> 00:33:53,359 the entire 784 00:33:50,119 --> 00:33:55,719 symmetric okay because that's a that's a 785 00:33:53,359 --> 00:33:59,558 channel is the it's the real it's a cost 786 00:33:55,720 --> 00:34:01,120 of capital Channel you know for the firm 787 00:33:59,558 --> 00:34:03,720 that's they're all entering exactly 788 00:34:01,119 --> 00:34:06,359 through the same the same place but the 789 00:34:03,720 --> 00:34:07,798 but the the FED doesn't control this guy 790 00:34:06,359 --> 00:34:11,519 it controls only the nominal interest 791 00:34:07,798 --> 00:34:14,159 rate okay so anyways so these are new 792 00:34:11,519 --> 00:34:17,960 parameters here so this is an example 793 00:34:14,159 --> 00:34:20,800 here that's an example in which credit 794 00:34:17,960 --> 00:34:25,519 spreads or respected inflation went 795 00:34:20,800 --> 00:34:29,720 up sorry whether CR spreads went down or 796 00:34:25,519 --> 00:34:31,119 expected inflation went up up okay and 797 00:34:29,719 --> 00:34:33,878 that's expansionary that will increase 798 00:34:31,119 --> 00:34:36,679 aggregate demand because for any given 799 00:34:33,878 --> 00:34:40,559 level of output now there will be more 800 00:34:36,679 --> 00:34:42,440 investment okay cre spreads are lower or 801 00:34:40,559 --> 00:34:43,719 expected inflation is higher mean the 802 00:34:42,440 --> 00:34:46,119 real interest rate is lower for any 803 00:34:43,719 --> 00:34:48,519 given nominal interest rate so if the if 804 00:34:46,119 --> 00:34:51,639 if the FED doesn't react to that that's 805 00:34:48,519 --> 00:34:51,639 going to lead to an expansion in 806 00:34:52,719 --> 00:34:57,439 output of course the FED could react to 807 00:34:55,119 --> 00:34:59,960 that suppose the FED is okay with the 808 00:34:57,440 --> 00:35:02,760 level of output we 809 00:34:59,960 --> 00:35:05,800 have okay suppose it's a level of output 810 00:35:02,760 --> 00:35:07,599 and the F seeing credit spreads falling 811 00:35:05,800 --> 00:35:09,640 so output is expanding but the FED says 812 00:35:07,599 --> 00:35:12,160 no no no the level of output y z was 813 00:35:09,639 --> 00:35:13,799 what I needed I don't want y1 what would 814 00:35:12,159 --> 00:35:17,199 the FED 815 00:35:13,800 --> 00:35:18,920 do increase the interest rate exactly 816 00:35:17,199 --> 00:35:21,519 and it's very easy to see in this 817 00:35:18,920 --> 00:35:23,680 expression here that that if you don't 818 00:35:21,519 --> 00:35:26,320 want this guy the total sum to move then 819 00:35:23,679 --> 00:35:30,358 if this guy moves down or or this guy 820 00:35:26,320 --> 00:35:32,119 moves up then I need to move I exactly 821 00:35:30,358 --> 00:35:33,400 to offset that and that's it it's very 822 00:35:32,119 --> 00:35:35,680 easy to calculate I don't need to solve 823 00:35:33,400 --> 00:35:37,680 my whole model actually you know you 824 00:35:35,679 --> 00:35:39,399 tell me this thing in net went down by 825 00:35:37,679 --> 00:35:41,000 100 basis points if I don't want to 826 00:35:39,400 --> 00:35:42,599 change output then I need to increase 827 00:35:41,000 --> 00:35:45,079 the interest rate by 100 basis points so 828 00:35:42,599 --> 00:35:46,760 I don't change the cost of borrowing the 829 00:35:45,079 --> 00:35:49,560 effective cost of borrowing for 830 00:35:46,760 --> 00:35:51,760 corporations 831 00:35:49,559 --> 00:35:55,318 okay in fact this is exactly what is 832 00:35:51,760 --> 00:35:57,839 going on right now in the US economy you 833 00:35:55,318 --> 00:35:59,358 know every time markets get very excited 834 00:35:57,838 --> 00:36:01,199 credit specs are compressed the stock 835 00:35:59,358 --> 00:36:03,000 market goes up the FED comes out and say 836 00:36:01,199 --> 00:36:05,639 come on guys I mean we have inflation 837 00:36:03,000 --> 00:36:07,280 problem I'm going to need to keep hiking 838 00:36:05,639 --> 00:36:10,118 interest rates 839 00:36:07,280 --> 00:36:12,119 because I need to offset Your 840 00:36:10,119 --> 00:36:14,160 Enthusiasm they don't use those words 841 00:36:12,119 --> 00:36:16,800 but that's exactly what happened I mean 842 00:36:14,159 --> 00:36:18,679 chairman pow was testifying in Congress 843 00:36:16,800 --> 00:36:21,079 yesterday and today and that's what he 844 00:36:18,679 --> 00:36:24,919 said I me just giving you a summary of 845 00:36:21,079 --> 00:36:24,920 what he said okay 846 00:36:29,000 --> 00:36:32,119 now a problem that the Central Bank May 847 00:36:30,679 --> 00:36:34,679 face suppose you have the opposite 848 00:36:32,119 --> 00:36:36,838 situation is that one in which credit 849 00:36:34,679 --> 00:36:39,318 spreads are going up a lot and expected 850 00:36:36,838 --> 00:36:40,920 inflation is declining a lot and the FED 851 00:36:39,318 --> 00:36:42,639 doesn't want output to the client 852 00:36:40,920 --> 00:36:44,680 because that combination will lead to 853 00:36:42,639 --> 00:36:48,519 reduction in output so the FED wants to 854 00:36:44,679 --> 00:36:48,519 cut interest rate what problem may it 855 00:36:49,358 --> 00:36:54,519 face it's zero lower bound it may not be 856 00:36:52,159 --> 00:36:56,879 able to bring interest rate as much as 857 00:36:54,519 --> 00:37:00,239 because suppose that the the interest 858 00:36:56,880 --> 00:37:02,358 rate today is is a is a 50 basis point 859 00:37:00,239 --> 00:37:06,919 it's not the case today but it was two 860 00:37:02,358 --> 00:37:09,400 years ago 50 basis point 25 basis points 861 00:37:06,920 --> 00:37:11,599 and cre spreads go up by 200 basis 862 00:37:09,400 --> 00:37:14,680 points well there's no way the FED can 863 00:37:11,599 --> 00:37:17,039 upset that no because he has maximum 25 864 00:37:14,679 --> 00:37:18,719 basis points to lower and cre the spread 865 00:37:17,039 --> 00:37:20,400 went up by 100 basis points and that's 866 00:37:18,719 --> 00:37:22,799 when you start seeing all these more 867 00:37:20,400 --> 00:37:25,200 exotic policies quantitive eing and 868 00:37:22,800 --> 00:37:26,680 other things to offset the negative 869 00:37:25,199 --> 00:37:29,039 impact of the of the increase in the 870 00:37:26,679 --> 00:37:31,799 greater spreads in the 871 00:37:29,039 --> 00:37:34,759 economy and the last thing we we did was 872 00:37:31,800 --> 00:37:39,039 to begin a 873 00:37:34,760 --> 00:37:41,200 a our transitions to medium run issues 874 00:37:39,039 --> 00:37:43,079 and and the whole thing began from the 875 00:37:41,199 --> 00:37:44,399 labor market now you're going to get a 876 00:37:43,079 --> 00:37:46,039 little bit in the quiz of that but it's 877 00:37:44,400 --> 00:37:47,519 not going to be as important as what I 878 00:37:46,039 --> 00:37:48,639 just described but a little bit you're 879 00:37:47,519 --> 00:37:52,920 going to 880 00:37:48,639 --> 00:37:55,039 have and the basic uh well definitions 881 00:37:52,920 --> 00:37:58,119 you should should know the basic 882 00:37:55,039 --> 00:38:00,119 definitions well this was the first a a 883 00:37:58,119 --> 00:38:02,640 important equation we have a a wage 884 00:38:00,119 --> 00:38:05,119 setting equation that says essentially 885 00:38:02,639 --> 00:38:06,799 that wages are increasing in expected 886 00:38:05,119 --> 00:38:08,039 prices obviously the nominal wage the 887 00:38:06,800 --> 00:38:10,079 workers are going to demand is going to 888 00:38:08,039 --> 00:38:13,159 be higher if they expect the price level 889 00:38:10,079 --> 00:38:15,440 to be higher in the future but important 890 00:38:13,159 --> 00:38:17,759 is decreasing in unemployment and 891 00:38:15,440 --> 00:38:19,280 increasing in this in this variable that 892 00:38:17,760 --> 00:38:23,400 represents sort of their bargaining 893 00:38:19,280 --> 00:38:24,880 power and so on H then we look at what 894 00:38:23,400 --> 00:38:27,720 happened on the on the product on the 895 00:38:24,880 --> 00:38:28,960 price setting side meaning what firms do 896 00:38:27,719 --> 00:38:30,759 and for that we had to start with the 897 00:38:28,960 --> 00:38:32,119 production function we had a very simple 898 00:38:30,760 --> 00:38:33,599 production function which said if you 899 00:38:32,119 --> 00:38:36,200 want to produce one more unit of the 900 00:38:33,599 --> 00:38:37,640 good you need to have one more worker 901 00:38:36,199 --> 00:38:39,598 that means that the marginal cost of 902 00:38:37,639 --> 00:38:41,519 production is the wage so it's very 903 00:38:39,599 --> 00:38:43,559 simple and then we said we're going to 904 00:38:41,519 --> 00:38:46,199 have a very simple model in which the 905 00:38:43,559 --> 00:38:48,920 the firms charge their marginal cost 906 00:38:46,199 --> 00:38:52,118 which is the wage times a marup 1 plus M 907 00:38:48,920 --> 00:38:54,639 so m is a number like say2 okay so if 908 00:38:52,119 --> 00:38:57,240 the wage is 100 the markup is 20% they 909 00:38:54,639 --> 00:39:00,440 want the price of they're want to charge 910 00:38:57,239 --> 00:39:03,439 a price of 120 we can rearrange this in 911 00:39:00,440 --> 00:39:05,760 terms of wages and you can say well the 912 00:39:03,440 --> 00:39:07,760 firm the maximum real wage that firms 913 00:39:05,760 --> 00:39:10,319 collectively are willing to pay is 914 00:39:07,760 --> 00:39:15,040 really one over one plus the market okay 915 00:39:10,318 --> 00:39:16,838 that's just from that so then we look at 916 00:39:15,039 --> 00:39:18,599 a concept that that is important which 917 00:39:16,838 --> 00:39:20,639 is the natural rate of unemployment and 918 00:39:18,599 --> 00:39:24,000 we said the natural rate of unemployment 919 00:39:20,639 --> 00:39:26,960 has nothing of natural it just means 920 00:39:24,000 --> 00:39:29,318 that is the level of unemployment when 921 00:39:26,960 --> 00:39:30,880 the price is equal to expected price or 922 00:39:29,318 --> 00:39:34,079 expected price equal to the price you 923 00:39:30,880 --> 00:39:35,720 pick okay so all that we did was to 924 00:39:34,079 --> 00:39:37,839 replacing the weight setting equation 925 00:39:35,719 --> 00:39:40,239 the expected price for the actual price 926 00:39:37,838 --> 00:39:42,799 and then we divided both sides and now 927 00:39:40,239 --> 00:39:44,799 we have this real wage Demand by by 928 00:39:42,800 --> 00:39:46,839 workers when the price is equal to 929 00:39:44,800 --> 00:39:49,400 expected price and we also had a price 930 00:39:46,838 --> 00:39:53,078 set in equation we can and I said when 931 00:39:49,400 --> 00:39:56,000 we replace P for p then I get the right 932 00:39:53,079 --> 00:39:57,560 to put an n superscript n there that's 933 00:39:56,000 --> 00:39:58,838 the natural rate of unemployment because 934 00:39:57,559 --> 00:40:01,039 that's my definition of the natural rate 935 00:39:58,838 --> 00:40:03,679 ofemployment what happens when I can 936 00:40:01,039 --> 00:40:07,039 replace in the weight setting equation H 937 00:40:03,679 --> 00:40:08,639 the the expected price for the price and 938 00:40:07,039 --> 00:40:10,400 we look at the at the natural rate of 939 00:40:08,639 --> 00:40:13,559 unemployment what is equilibrium here of 940 00:40:10,400 --> 00:40:16,079 the price setting equation has an imply 941 00:40:13,559 --> 00:40:18,679 real wage of 1 over 1 plus M and that's 942 00:40:16,079 --> 00:40:20,119 a wage setting equation which is 943 00:40:18,679 --> 00:40:21,440 obviously decreasing unemployment 944 00:40:20,119 --> 00:40:23,358 because the higher is unemployment the 945 00:40:21,440 --> 00:40:25,960 lower the wage Demand by the workers 946 00:40:23,358 --> 00:40:27,838 okay and that's one natural rate of 947 00:40:25,960 --> 00:40:30,079 unemployment again nothing natural is a 948 00:40:27,838 --> 00:40:31,480 function of parameters which parameters 949 00:40:30,079 --> 00:40:33,280 well it's a function of that markup 950 00:40:31,480 --> 00:40:36,719 parameter it's a function of this 951 00:40:33,280 --> 00:40:40,280 institutional variable Z for example 952 00:40:36,719 --> 00:40:41,559 okay so that's in equations that's an 953 00:40:40,280 --> 00:40:45,359 example in 954 00:40:41,559 --> 00:40:47,960 which Z goes up so suppose that somehow 955 00:40:45,358 --> 00:40:49,799 you know unions go up or something like 956 00:40:47,960 --> 00:40:52,960 unionization goes up something of that 957 00:40:49,800 --> 00:40:54,640 kind or an employment benefits go up 958 00:40:52,960 --> 00:40:56,519 something of that kind which in in 959 00:40:54,639 --> 00:40:58,039 principle is supportive of workers well 960 00:40:56,519 --> 00:40:59,440 in this model 961 00:40:58,039 --> 00:41:02,119 that will immediately lead to an 962 00:40:59,440 --> 00:41:04,880 increasing wage demand for at this level 963 00:41:02,119 --> 00:41:05,960 of unemployment there going to be a a 964 00:41:04,880 --> 00:41:08,559 higher 965 00:41:05,960 --> 00:41:09,800 demand higher real wage Demand by the 966 00:41:08,559 --> 00:41:12,599 workers because they have more 967 00:41:09,800 --> 00:41:15,400 bargaining power now in this particular 968 00:41:12,599 --> 00:41:17,680 model that that cannot happen because 969 00:41:15,400 --> 00:41:20,358 the real wage that firms can are willing 970 00:41:17,679 --> 00:41:22,480 to pay is only this one one plus M so in 971 00:41:20,358 --> 00:41:24,598 order to restore equilibrium in the in 972 00:41:22,480 --> 00:41:26,119 the labor market what has to happen is 973 00:41:24,599 --> 00:41:27,760 unemployment natural rate of 974 00:41:26,119 --> 00:41:29,160 unemployment will go up 975 00:41:27,760 --> 00:41:31,800 and and that that will restore 976 00:41:29,159 --> 00:41:33,639 equilibrium here because well workers 977 00:41:31,800 --> 00:41:36,079 the the the bargaining power workers 978 00:41:33,639 --> 00:41:39,519 gain through those benefits in Z they 979 00:41:36,079 --> 00:41:41,599 end up losing by an increas in the 980 00:41:39,519 --> 00:41:42,599 equilibrium level of unemployment okay 981 00:41:41,599 --> 00:41:45,800 so that's the 982 00:41:42,599 --> 00:41:47,599 reason hear this stuff backfiring as to 983 00:41:45,800 --> 00:41:49,920 the workers because you know you end up 984 00:41:47,599 --> 00:41:51,838 with higher natural rate of unemployment 985 00:41:49,920 --> 00:41:53,720 so Europe for example has much higher 986 00:41:51,838 --> 00:41:55,559 labor protection than the US well they 987 00:41:53,719 --> 00:41:57,919 typically have a much higher 988 00:41:55,559 --> 00:41:59,920 unemployment rate than the US okay so 989 00:41:57,920 --> 00:42:02,280 that tradeoffs all these 990 00:41:59,920 --> 00:42:04,639 things that's a case of increaseing the 991 00:42:02,280 --> 00:42:07,720 markup and increasing the markup means 992 00:42:04,639 --> 00:42:10,279 effectively that the firms are going 993 00:42:07,719 --> 00:42:11,919 offering a lower real wage well at this 994 00:42:10,280 --> 00:42:14,119 level of unemployment workers are not 995 00:42:11,920 --> 00:42:15,800 going to take that lower real wage so 996 00:42:14,119 --> 00:42:18,079 what will have to happen for workers to 997 00:42:15,800 --> 00:42:20,039 take that low lower real wage is for 998 00:42:18,079 --> 00:42:21,680 unemployment to rise okay so those are 999 00:42:20,039 --> 00:42:23,639 the two canonical experiments you can 1000 00:42:21,679 --> 00:42:26,440 have here it's what happens when markets 1001 00:42:23,639 --> 00:42:30,039 go up and that can go they can go up for 1002 00:42:26,440 --> 00:42:31,760 for the wrong reason it could be for oil 1003 00:42:30,039 --> 00:42:33,279 shocks and stuff like that it could be 1004 00:42:31,760 --> 00:42:36,160 because the market becomes less 1005 00:42:33,280 --> 00:42:38,640 competitive allistic firms and so on but 1006 00:42:36,159 --> 00:42:39,759 the final outcome here is that we end up 1007 00:42:38,639 --> 00:42:42,000 with a higher natural rate of 1008 00:42:39,760 --> 00:42:43,640 unemployment which again highlights the 1009 00:42:42,000 --> 00:42:46,199 idea that this is not a g given 1010 00:42:43,639 --> 00:42:47,799 unemployment rate so it's not it's not 1011 00:42:46,199 --> 00:42:50,439 good in any sense it's it's just 1012 00:42:47,800 --> 00:42:50,440 whatever it is the 1013 00:42:51,440 --> 00:42:56,200 equilibri okay uh anyway so you should 1014 00:42:54,719 --> 00:42:59,159 understand well what these two type of 1015 00:42:56,199 --> 00:43:02,000 shocks do to the natur rate of 1016 00:42:59,159 --> 00:43:06,159 unemployment I think that's because then 1017 00:43:02,000 --> 00:43:06,159 lecture nine is not for this this 1018 00:43:06,400 --> 00:43:11,119 quiz that's all I want to say any any 1019 00:43:13,000 --> 00:43:16,000 questions 1020 00:43:21,800 --> 00:43:24,800 no 1021 00:43:25,079 --> 00:43:33,680 y this I think so I think is that the 1022 00:43:28,559 --> 00:43:37,559 same a as next to the yeah this is the 1023 00:43:33,679 --> 00:43:41,000 C you you want me to explain this this 1024 00:43:37,559 --> 00:43:42,760 this yeah yeah it is a CR spread I said 1025 00:43:41,000 --> 00:43:45,599 that's the way you calculate this CR 1026 00:43:42,760 --> 00:43:50,440 spread here it's um remember there are 1027 00:43:45,599 --> 00:43:50,440 two reasons why why 1028 00:43:51,280 --> 00:43:59,000 um do you really want to 1029 00:43:54,760 --> 00:44:00,760 know in anyway let me let me say so 1030 00:43:59,000 --> 00:44:03,559 there are two reasons why the credit 1031 00:44:00,760 --> 00:44:06,160 Express really happen one is the actual 1032 00:44:03,559 --> 00:44:08,040 probability of the fault of a bond which 1033 00:44:06,159 --> 00:44:09,519 the treasury has a very low priority def 1034 00:44:08,039 --> 00:44:11,759 fall corporations depending on the 1035 00:44:09,519 --> 00:44:13,119 ratings they may have higher or lower 1036 00:44:11,760 --> 00:44:15,559 and the other one which is very 1037 00:44:13,119 --> 00:44:18,318 significant is how risk averse investors 1038 00:44:15,559 --> 00:44:21,440 are and that risk aversion changes a lot 1039 00:44:18,318 --> 00:44:23,480 over the business cycle H we capture 1040 00:44:21,440 --> 00:44:25,440 everything through just that X spread 1041 00:44:23,480 --> 00:44:27,199 which we we capture it through this 1042 00:44:25,440 --> 00:44:28,679 probability of theault but you can think 1043 00:44:27,199 --> 00:44:30,439 that prity of the fault as being the 1044 00:44:28,679 --> 00:44:31,879 perceived priority of the fault and when 1045 00:44:30,440 --> 00:44:34,800 you're very scared you perceive that 1046 00:44:31,880 --> 00:44:36,640 terrible things can happen so so it's a 1047 00:44:34,800 --> 00:44:39,359 subjective priority of the 1048 00:44:36,639 --> 00:44:40,799 fault so when that priority of the fault 1049 00:44:39,358 --> 00:44:42,759 is different from zero then you start 1050 00:44:40,800 --> 00:44:45,839 getting a positive 1051 00:44:42,760 --> 00:44:48,720 spread how impactful is the actual def I 1052 00:44:45,838 --> 00:44:50,358 know there were some recent defaults in 1053 00:44:48,719 --> 00:44:53,279 at least the European like real estate 1054 00:44:50,358 --> 00:44:55,799 markets yeah um like how I guess is 1055 00:44:53,280 --> 00:44:57,839 there a difference between like a fear 1056 00:44:55,800 --> 00:45:00,240 of a default and like an actual 1057 00:44:57,838 --> 00:45:02,239 implications as oh this is all about 1058 00:45:00,239 --> 00:45:05,159 perceived risk so it's because this is 1059 00:45:02,239 --> 00:45:06,959 this determines the the borrowing that 1060 00:45:05,159 --> 00:45:09,000 firms can do the cost for firms of 1061 00:45:06,960 --> 00:45:11,039 borrowing if you already defaulted you 1062 00:45:09,000 --> 00:45:12,838 cannot borrow so that's that's over that 1063 00:45:11,039 --> 00:45:14,920 that has other consequences it may have 1064 00:45:12,838 --> 00:45:17,078 impact on the balance sheet of the banks 1065 00:45:14,920 --> 00:45:19,280 it's destruction of wealth it may lead 1066 00:45:17,079 --> 00:45:20,599 to other problems but the problem we're 1067 00:45:19,280 --> 00:45:22,319 highlighting here in this model is the 1068 00:45:20,599 --> 00:45:26,680 cost of borrowing and that is something 1069 00:45:22,318 --> 00:45:26,679 that happens only before you default 1070 00:45:28,920 --> 00:45:33,880 yeah I mean actual defaults especially 1071 00:45:32,239 --> 00:45:35,679 typically in developers and stuff like 1072 00:45:33,880 --> 00:45:39,039 that can and that's what happen in the 1073 00:45:35,679 --> 00:45:40,358 Great Recession ER can have consequences 1074 00:45:39,039 --> 00:45:42,639 especially for the 1075 00:45:40,358 --> 00:45:45,799 banks that typically lend to this 1076 00:45:42,639 --> 00:45:47,679 developers and so on but I I may do 1077 00:45:45,800 --> 00:45:51,000 something about financial crisis but 1078 00:45:47,679 --> 00:45:52,558 much later in the course at the end okay 1079 00:45:51,000 --> 00:45:55,079 well good luck enjoy it if you 1080 00:45:52,559 --> 00:45:59,960 understood what I said today you're 1081 00:45:55,079 --> 00:45:59,960 you're in good shape for