WEBVTT 00:00:16.719 --> 00:00:22.879 um so we started with the something a 00:00:20.079 --> 00:00:25.079 little boring basic definitions and the 00:00:22.879 --> 00:00:26.480 first thing we had to do is to 00:00:25.079 --> 00:00:28.198 understand how do we measure output at 00:00:26.480 --> 00:00:29.599 the aggregate level it's very easy to 00:00:28.199 --> 00:00:32.679 understand what output is at the level 00:00:29.599 --> 00:00:36.200 of an Factory but but at the AG level is 00:00:32.679 --> 00:00:38.799 a little tricky and so we had an example 00:00:36.200 --> 00:00:41.440 of a very simple economy with two 00:00:38.799 --> 00:00:44.439 companies one that produces steel and 00:00:41.439 --> 00:00:46.359 the other one that produces cars and in 00:00:44.439 --> 00:00:47.799 this particular example the steel 00:00:46.359 --> 00:00:50.079 company doesn't sell anything to the 00:00:47.799 --> 00:00:52.599 final consumers it sells all its 00:00:50.079 --> 00:00:54.640 production to the car company and we ask 00:00:52.600 --> 00:00:58.120 a question where is the GDP of this 00:00:54.640 --> 00:01:01.640 economy H the simplest answer would have 00:00:58.119 --> 00:01:03.439 been well 300 no I some what the the the 00:01:01.640 --> 00:01:06.879 output of the two companies and that 00:01:03.439 --> 00:01:08.719 could be one answer but then I show you 00:01:06.879 --> 00:01:12.599 through three different methods that 00:01:08.719 --> 00:01:18.319 that's the wrong answer and um method 00:01:12.599 --> 00:01:22.438 one H was h a definition is um GDP is 00:01:18.319 --> 00:01:25.438 the value of final goods only okay and 00:01:22.438 --> 00:01:26.959 final goods in this simple example is 00:01:25.438 --> 00:01:29.399 well this company is not producing 00:01:26.959 --> 00:01:31.919 anything as a final good because all its 00:01:29.400 --> 00:01:34.960 sales are going to as an input into 00:01:31.920 --> 00:01:36.799 other companies production and so this 00:01:34.959 --> 00:01:38.839 one doesn't count at all in our simple 00:01:36.799 --> 00:01:42.560 example this one counts and then the 00:01:38.840 --> 00:01:46.520 answer is $200 okay not 3300 but 00:01:42.560 --> 00:01:48.840 $200 method two was to count only the 00:01:46.519 --> 00:01:50.798 value added in each company and value 00:01:48.840 --> 00:01:51.920 added is the difference between the 00:01:50.799 --> 00:01:55.159 final 00:01:51.920 --> 00:01:57.640 output that is the revenue from sales 00:01:55.159 --> 00:02:00.280 minus whatever that company spends on 00:01:57.640 --> 00:02:02.319 intermediate inputs in this simple 00:02:00.280 --> 00:02:04.200 example this company the steel company 00:02:02.319 --> 00:02:05.959 is not spending anything on intermediate 00:02:04.200 --> 00:02:07.959 inputs it's a strange production of a 00:02:05.959 --> 00:02:11.000 steel but anyways it is what it is in 00:02:07.959 --> 00:02:13.400 example and so this is entire this $100 00:02:11.000 --> 00:02:15.519 is is value added completely value added 00:02:13.400 --> 00:02:18.719 there's no expenses on intermediate 00:02:15.519 --> 00:02:20.959 inputs for the car company however the 00:02:18.719 --> 00:02:23.359 revenue from C is 200 but the company 00:02:20.959 --> 00:02:25.039 spends 100 on intermediate input 00:02:23.360 --> 00:02:27.680 therefore the value out of this company 00:02:25.039 --> 00:02:29.719 is 200 minus 100 so you get 100 value 00:02:27.680 --> 00:02:33.239 out from this one 100 value out from 00:02:29.719 --> 00:02:35.759 that one total value added 200 so same 00:02:33.239 --> 00:02:37.640 answer and the third method these are 00:02:35.759 --> 00:02:39.439 the two method that I just described are 00:02:37.639 --> 00:02:42.238 production methods no you're measuring 00:02:39.439 --> 00:02:45.400 the production side the alternative is 00:02:42.239 --> 00:02:47.640 to look at the income side okay and the 00:02:45.400 --> 00:02:49.840 income side let's says just let's sum 00:02:47.639 --> 00:02:52.000 all the incomes in the economy and the 00:02:49.840 --> 00:02:54.319 incomes are income to workers wages and 00:02:52.000 --> 00:02:58.120 income to the owners of capital 00:02:54.318 --> 00:03:02.359 profits ER income to way to workers is 00:02:58.120 --> 00:03:05.439 $80 plus 70 is 100 50 income to owners 00:03:02.360 --> 00:03:08.120 of capital is 20 + 30 that's 50 so 150 00:03:05.439 --> 00:03:11.840 plus 50 is again 200 okay so these are 00:03:08.120 --> 00:03:15.280 three equivalent ways of er er measuring 00:03:11.840 --> 00:03:18.200 output and I said 00:03:15.280 --> 00:03:21.439 ER you know and one of the features I I 00:03:18.199 --> 00:03:25.079 I I show you of of of of this method is 00:03:21.439 --> 00:03:26.919 that they are immune to organizational 00:03:25.080 --> 00:03:28.640 structure within the economy so for 00:03:26.919 --> 00:03:31.639 example if these two companies were to 00:03:28.639 --> 00:03:34.598 merge no clearly the sum of incomes 00:03:31.639 --> 00:03:36.039 would not change would still be 100 it 00:03:34.598 --> 00:03:39.318 would be 00:03:36.039 --> 00:03:41.479 200 ER this one would not change because 00:03:39.318 --> 00:03:43.679 if they were to merge then the whole 00:03:41.479 --> 00:03:46.438 production of the revenues from sales of 00:03:43.680 --> 00:03:48.159 the car company would be value added 00:03:46.438 --> 00:03:50.400 everything would be produced in house 00:03:48.158 --> 00:03:51.919 and still the answer would be 200 then 00:03:50.400 --> 00:03:53.879 no because this company would disappear 00:03:51.919 --> 00:03:56.878 it would emerge inside here and you 00:03:53.878 --> 00:04:00.639 would get still get 200 and the same 00:03:56.878 --> 00:04:03.359 happen with h method one because still 00:04:00.639 --> 00:04:06.359 the sales of final goods is only 00:04:03.360 --> 00:04:09.079 200 the naive approach of just summing 00:04:06.360 --> 00:04:11.159 output you know would be terrible 00:04:09.079 --> 00:04:13.879 because once you merge it output would 00:04:11.158 --> 00:04:16.159 collapse from 300 to 200 that tells you 00:04:13.878 --> 00:04:18.560 that's not the right way of doing things 00:04:16.160 --> 00:04:22.840 okay so while the three methods we 00:04:18.560 --> 00:04:24.519 propose do H work are immune to to this 00:04:22.839 --> 00:04:28.039 organiz changes in organization 00:04:24.519 --> 00:04:30.038 structure The Next Step was to H 00:04:28.040 --> 00:04:32.879 highlight that when we say out output 00:04:30.038 --> 00:04:34.319 we're really after real output and 00:04:32.879 --> 00:04:37.639 there's a distinction between nominal 00:04:34.319 --> 00:04:39.879 output and real output nominal output is 00:04:37.639 --> 00:04:43.439 simply the quantity of final goods 00:04:39.879 --> 00:04:46.199 measured at current prices while real 00:04:43.439 --> 00:04:49.199 output is measured at some fixed set of 00:04:46.199 --> 00:04:50.478 prices okay of one fixed year and I 00:04:49.199 --> 00:04:52.639 think I gave you an 00:04:50.478 --> 00:04:54.478 example this is example I gave you and 00:04:52.639 --> 00:04:56.160 then in the in the in the pets you had 00:04:54.478 --> 00:04:58.279 more complicated examples with multiple 00:04:56.160 --> 00:05:00.199 Goods here you have an economy that 00:04:58.279 --> 00:05:03.279 produces only one good 00:05:00.199 --> 00:05:06.720 cars and that PES 10 cars here 12 cars 00:05:03.279 --> 00:05:09.599 here 13 cars here the price of the cars 00:05:06.720 --> 00:05:12.240 is rising so the nominal GDP is rising a 00:05:09.600 --> 00:05:14.800 lot while the real GDP is rising less 00:05:12.240 --> 00:05:16.840 how do we measure real GDP here we use 00:05:14.800 --> 00:05:19.600 to to 12 in this particular example we 00:05:16.839 --> 00:05:22.679 use the prices here 12 10 times the 00:05:19.600 --> 00:05:23.639 price of the car in 2012 is 24,000 00:05:22.680 --> 00:05:27.000 that's 00:05:23.639 --> 00:05:30.319 240 obviously for the base year nominal 00:05:27.000 --> 00:05:33.279 GDP is the same as real GDP and then 12 00:05:30.319 --> 00:05:36.560 13 is 13 not time 26,000 but times 00:05:33.279 --> 00:05:38.918 24,000 and we get that now in this 00:05:36.560 --> 00:05:42.120 particular example of only one e one 00:05:38.918 --> 00:05:43.839 good ER you can pick any any base year 00:05:42.120 --> 00:05:45.959 and you'll get exactly the same rate of 00:05:43.839 --> 00:05:47.478 growth of real output if you have 00:05:45.959 --> 00:05:49.079 multiple Goods that's not true because 00:05:47.478 --> 00:05:52.318 the relative prices of goods are moving 00:05:49.079 --> 00:05:55.399 over time okay but uh but that's the 00:05:52.319 --> 00:05:57.680 basic idea so I mean again you should 00:05:55.399 --> 00:05:59.120 know these things they're not going to 00:05:57.680 --> 00:06:01.100 be tremendously important in the quiz 00:05:59.120 --> 00:06:04.280 but they will show up in your quiz 00:06:01.100 --> 00:06:06.800 [Music] 00:06:04.279 --> 00:06:09.839 okay and then we went some some 00:06:06.800 --> 00:06:11.918 definitions the unemployment rate know 00:06:09.839 --> 00:06:14.478 being the number of unemployed over the 00:06:11.918 --> 00:06:18.918 labor force not population that's 00:06:14.478 --> 00:06:21.279 important H we talked about inflation 00:06:18.918 --> 00:06:22.879 rate as well that's the rate of change 00:06:21.279 --> 00:06:24.119 of prices and there are different prices 00:06:22.879 --> 00:06:26.800 in the economy one of them is the 00:06:24.120 --> 00:06:30.439 deflator the other one is CPI and so on 00:06:26.800 --> 00:06:32.759 so forth that's it so that was the first 00:06:30.439 --> 00:06:35.038 uh lecture relevant for the quiz any 00:06:32.759 --> 00:06:38.800 question about 00:06:35.038 --> 00:06:38.800 that good keep 00:06:39.279 --> 00:06:43.799 moving okay then we move to when then we 00:06:41.959 --> 00:06:46.638 began to really get serious because we 00:06:43.800 --> 00:06:49.439 began to construct sort of a foundation 00:06:46.639 --> 00:06:52.478 for the islm model okay and the first 00:06:49.439 --> 00:06:55.478 thing we did is we look at the Goods 00:06:52.478 --> 00:06:55.478 Market 00:06:55.879 --> 00:07:00.759 uh no and and what we did here is just 00:06:59.199 --> 00:07:03.960 was say we describ the different 00:07:00.759 --> 00:07:06.879 components of of aggregate demand and we 00:07:03.959 --> 00:07:08.478 said in this econ for for now at least 00:07:06.879 --> 00:07:10.720 we're going to make this economy close 00:07:08.478 --> 00:07:12.758 so we we remove exports and imports and 00:07:10.720 --> 00:07:15.240 for your quiz absolutely you not going 00:07:12.759 --> 00:07:18.439 to see anything about exports or Imports 00:07:15.240 --> 00:07:20.879 okay so this is your aggregate demand ER 00:07:18.439 --> 00:07:23.240 we wanted to build a little more so we 00:07:20.879 --> 00:07:25.160 had to have some behavioral assumptions 00:07:23.240 --> 00:07:26.560 H we made it initially very simple we 00:07:25.160 --> 00:07:28.639 assumed this was 00:07:26.560 --> 00:07:32.959 exogenous the Govern expension was 00:07:28.639 --> 00:07:35.038 exogenous taxes were also exogenous t h 00:07:32.959 --> 00:07:36.878 and the only behavioral equation we had 00:07:35.038 --> 00:07:38.918 was this consumption function we said 00:07:36.879 --> 00:07:42.360 consumption is increasing disposable 00:07:38.918 --> 00:07:44.318 income okay so and we we assume 00:07:42.360 --> 00:07:47.240 something linear like this disposable 00:07:44.319 --> 00:07:50.439 income is just income minus taxes and 00:07:47.240 --> 00:07:52.319 remember income remember from the from 00:07:50.439 --> 00:07:55.360 the alternative ways of measuring GDP 00:07:52.319 --> 00:07:57.840 income is the same as output no so when 00:07:55.360 --> 00:07:59.680 I say income because as is relevant for 00:07:57.839 --> 00:08:03.239 the consump consumer well but it's the 00:07:59.680 --> 00:08:05.360 same as output so that's was our 00:08:03.240 --> 00:08:07.360 consumption function it had an upward 00:08:05.360 --> 00:08:10.400 slope it was upward sloping because 00:08:07.360 --> 00:08:14.520 there's a marginal propensity to consume 00:08:10.399 --> 00:08:17.878 C1 H and then then a key Assumption of 00:08:14.519 --> 00:08:19.680 this part of the course is that that H 00:08:17.879 --> 00:08:22.840 output is aggregate demand determined 00:08:19.680 --> 00:08:24.959 prices were completely fixed H and and 00:08:22.839 --> 00:08:26.959 we said well but you know output is 00:08:24.959 --> 00:08:30.918 whatever demand wants that's what output 00:08:26.959 --> 00:08:33.399 is so this is an equilibrium condition 00:08:30.918 --> 00:08:35.399 okay this is the aggregate demand this 00:08:33.399 --> 00:08:37.120 is an equilibrium condition so we can 00:08:35.399 --> 00:08:40.038 solve out because I can say in 00:08:37.120 --> 00:08:41.799 equilibrium Z is equal to Y and I can 00:08:40.038 --> 00:08:43.759 solve for equilibrium output from that 00:08:41.799 --> 00:08:46.120 equation okay and that's exactly what we 00:08:43.759 --> 00:08:48.759 did in this slide and you got to an 00:08:46.120 --> 00:08:51.159 expression like this knowing how to do 00:08:48.759 --> 00:08:52.679 that is very important for you okay so 00:08:51.159 --> 00:08:56.719 you you better be sure that you know how 00:08:52.679 --> 00:08:58.759 to find equilibrium output in in in this 00:08:56.720 --> 00:09:00.639 model I mean it's going to be very 00:08:58.759 --> 00:09:03.759 difficult to do I M if you don't know 00:09:00.639 --> 00:09:06.958 these steps so so you better know this 00:09:03.759 --> 00:09:08.958 stuff H and remember something we call 00:09:06.958 --> 00:09:11.319 this guy here in the simple economy the 00:09:08.958 --> 00:09:13.000 multiplier why the multiplier well 00:09:11.320 --> 00:09:16.839 because given certain sort of something 00:09:13.000 --> 00:09:20.720 we call exogenous expenditure the 1 00:09:16.839 --> 00:09:23.480 minus C1 multiplies that if the marginal 00:09:20.720 --> 00:09:25.800 to consume is very high say it's close 00:09:23.480 --> 00:09:28.360 to one then the multipli is very very 00:09:25.799 --> 00:09:32.240 high if the marginal Pro to consume say 00:09:28.360 --> 00:09:32.240 is 05 then how much is the 00:09:33.480 --> 00:09:40.920 multiplier two okay good so the 00:09:36.639 --> 00:09:42.838 multiplier is two okay good and that was 00:09:40.919 --> 00:09:44.919 our equilibrium now we had the aggregate 00:09:42.839 --> 00:09:46.839 demand the slope was less than the 45 00:09:44.919 --> 00:09:48.838 degree line because C1 is a number less 00:09:46.839 --> 00:09:50.360 than one and so you have some 00:09:48.839 --> 00:09:52.480 equilibrium output there that's 00:09:50.360 --> 00:09:55.519 equilibrium output at this point 00:09:52.480 --> 00:09:57.200 aggregate demand is equal to well agre 00:09:55.519 --> 00:09:59.639 demand is equal to agre supply that's 00:09:57.200 --> 00:10:01.519 that's always true uh but that's 00:09:59.639 --> 00:10:03.480 consistent also with aggregate demand 00:10:01.519 --> 00:10:06.759 okay with the with the function of 00:10:03.480 --> 00:10:08.920 aggregate demand and and the important 00:10:06.759 --> 00:10:10.759 for for this equilibrium output is that 00:10:08.919 --> 00:10:11.958 that equilibrium output is a function of 00:10:10.759 --> 00:10:13.838 a lot of things that we took as 00:10:11.958 --> 00:10:16.078 parameters in this aggregate demand 00:10:13.839 --> 00:10:20.320 curve what did we take as parameters in 00:10:16.078 --> 00:10:20.319 the agregate bank care just give 00:10:22.480 --> 00:10:29.159 examples well investment government 00:10:26.320 --> 00:10:31.320 expenditure and taxes at the very least 00:10:29.159 --> 00:10:34.199 tax also parameters like autonomous 00:10:31.320 --> 00:10:36.839 consumption that c0 were taking as given 00:10:34.200 --> 00:10:38.360 anything if any of those things move 00:10:36.839 --> 00:10:40.360 this the position of this aggregate 00:10:38.360 --> 00:10:43.800 demand curve will shift 00:10:40.360 --> 00:10:46.000 around okay and that was one example 00:10:43.799 --> 00:10:48.000 suppose autonomous consumption C zero 00:10:46.000 --> 00:10:51.480 goes up so suddenly consumers decide to 00:10:48.000 --> 00:10:54.278 spend more okay well then then what we 00:10:51.480 --> 00:10:56.399 had is is that aggregate demand shift up 00:10:54.278 --> 00:10:59.000 and equilibrium output ends up changing 00:10:56.399 --> 00:10:59.839 by more than the initial change in c z 00:10:59.000 --> 00:11:02.600 why is 00:10:59.839 --> 00:11:04.160 that so this is the change in 00:11:02.600 --> 00:11:07.839 c0 00:11:04.159 --> 00:11:10.120 but uh but the change in output and so 00:11:07.839 --> 00:11:12.240 the initial change c0 leads to an 00:11:10.120 --> 00:11:15.320 initial change in output which is equal 00:11:12.240 --> 00:11:17.360 to c0 that's up to here but then we end 00:11:15.320 --> 00:11:20.200 up with final equilibrium output is is 00:11:17.360 --> 00:11:21.959 is higher than the initial response all 00:11:20.200 --> 00:11:26.519 this happens infinitely fast in this 00:11:21.958 --> 00:11:28.919 model why is this change greater than 00:11:26.519 --> 00:11:30.039 c0 there is a multiplier in front 00:11:28.919 --> 00:11:32.599 exactly 00:11:30.039 --> 00:11:34.879 we change c0 by one but then you have to 00:11:32.600 --> 00:11:37.200 multiply by 1/ 1 minus C1 and that's 00:11:34.879 --> 00:11:41.278 what we Illustrated in this picture 00:11:37.200 --> 00:11:43.240 there okay good and so you should move 00:11:41.278 --> 00:11:47.720 anything you you can move here around no 00:11:43.240 --> 00:11:50.120 move G up T up or stuff like that and 00:11:47.720 --> 00:11:52.278 see what 00:11:50.120 --> 00:11:54.560 happens the last thing I did in this 00:11:52.278 --> 00:11:56.639 section is is uh I show you an 00:11:54.559 --> 00:12:00.000 alternative way entirely equivalent way 00:11:56.639 --> 00:12:01.680 of of illustrating equilibrium which was 00:12:00.000 --> 00:12:05.320 saving equal to 00:12:01.679 --> 00:12:07.559 investment H remember and I derive 00:12:05.320 --> 00:12:08.879 this and I got to an expression like 00:12:07.559 --> 00:12:10.359 that that's exactly the same as 00:12:08.879 --> 00:12:13.759 aggregate demand equal to aggregate 00:12:10.360 --> 00:12:16.600 supply no a investment which in this 00:12:13.759 --> 00:12:18.159 particular basic model is fixed is equal 00:12:16.600 --> 00:12:19.720 to saving by the government which is 00:12:18.159 --> 00:12:23.198 also in this basic model is fixed 00:12:19.720 --> 00:12:26.720 because it's G minus t which is fixed H 00:12:23.198 --> 00:12:29.359 sorry it's T minus G which is fixed and 00:12:26.720 --> 00:12:32.879 then private saving and and then I show 00:12:29.360 --> 00:12:34.720 you a an interesting result which is 00:12:32.879 --> 00:12:37.000 called known the Paradox of savings 00:12:34.720 --> 00:12:40.079 which says the following if for whatever 00:12:37.000 --> 00:12:43.440 reason consumers decide to save more say 00:12:40.078 --> 00:12:46.078 for example because c z now comes down 00:12:43.440 --> 00:12:47.519 okay so now out they have certain income 00:12:46.078 --> 00:12:48.399 out of that same income they want to 00:12:47.519 --> 00:12:51.360 save 00:12:48.399 --> 00:12:56.000 more then from this very simple equation 00:12:51.360 --> 00:12:56.000 I know that what happens to Output 00:13:02.600 --> 00:13:07.480 why because savings go up consum Dem 00:13:06.000 --> 00:13:10.958 goes down and then also investment 00:13:07.480 --> 00:13:13.120 suppos to go down and then no investment 00:13:10.958 --> 00:13:17.039 doesn't go down here because it's fixed 00:13:13.120 --> 00:13:19.959 in this this B Bas basic example not 00:13:17.039 --> 00:13:21.719 islm yes but that's that's that's an 00:13:19.958 --> 00:13:24.078 explanation which is is the right 00:13:21.720 --> 00:13:26.120 explanation but it's is it's the 00:13:24.078 --> 00:13:29.559 explanation in the other space output 00:13:26.120 --> 00:13:31.480 and and and and the income 00:13:29.559 --> 00:13:33.799 I want it in the space of saving an 00:13:31.480 --> 00:13:35.800 investment so let me give it to you very 00:13:33.799 --> 00:13:37.879 quickly but your answer is correct but 00:13:35.799 --> 00:13:39.078 but but it's not what I wanted here 00:13:37.879 --> 00:13:41.399 because what I wanted to say is the 00:13:39.078 --> 00:13:44.039 following if for whatever reason for any 00:13:41.399 --> 00:13:46.240 given level of income savings go up then 00:13:44.039 --> 00:13:47.360 we have an imbalance saving total saving 00:13:46.240 --> 00:13:49.480 is greater than 00:13:47.360 --> 00:13:52.039 investment the only variable that can 00:13:49.480 --> 00:13:54.240 adjust here so we restore equilibrium 00:13:52.039 --> 00:13:55.958 investment equal to saving is for output 00:13:54.240 --> 00:13:57.839 to bring come down because if output 00:13:55.958 --> 00:14:00.159 comes down savings come down and that's 00:13:57.839 --> 00:14:01.920 the way you restore equilibrium 00:14:00.159 --> 00:14:03.799 I told you this way of looking at thing 00:14:01.919 --> 00:14:06.000 is entirely equivalent as we had already 00:14:03.799 --> 00:14:08.559 done so I can also do what you wanted to 00:14:06.000 --> 00:14:11.559 do which is represent that in the space 00:14:08.559 --> 00:14:15.879 of output and aggregate demand and and 00:14:11.559 --> 00:14:17.119 output or or income and and the an 00:14:15.879 --> 00:14:20.759 increase in 00:14:17.120 --> 00:14:22.278 c0 a reduction in c0 would lead to a 00:14:20.759 --> 00:14:24.039 decline in aggregate demand and then 00:14:22.278 --> 00:14:25.799 through the multiply larger increase in 00:14:24.039 --> 00:14:28.360 output so this is the way we characteriz 00:14:25.799 --> 00:14:30.958 it before this is a slightly different 00:14:28.360 --> 00:14:32.240 way of of characterizing which is is 00:14:30.958 --> 00:14:33.919 what gives rise to what is called the 00:14:32.240 --> 00:14:36.360 Paradox of saving because suddenly you 00:14:33.919 --> 00:14:37.679 decide to save more supposed to be good 00:14:36.360 --> 00:14:42.039 well in the short run it's not really 00:14:37.679 --> 00:14:43.638 good it causes a recession okay anyway 00:14:42.039 --> 00:14:48.599 it's cute but it may show up in your 00:14:43.639 --> 00:14:48.600 future so I wanted to remind you 00:15:01.639 --> 00:15:07.639 so that was the Goods Market side 00:15:05.078 --> 00:15:09.599 oops then we look at financial markets 00:15:07.639 --> 00:15:11.320 and we we trivialized financial markets 00:15:09.600 --> 00:15:13.480 really we said let's assume the 00:15:11.320 --> 00:15:19.759 financial markets are very very simple 00:15:13.480 --> 00:15:19.759 money and bonds that's it nothing else 00:15:20.000 --> 00:15:25.198 ER and the first sort of behavior the 00:15:23.639 --> 00:15:27.278 the only behavioral equation we really 00:15:25.198 --> 00:15:29.159 had here was money demand and we say 00:15:27.278 --> 00:15:31.639 well money demand is increasing in nomal 00:15:29.159 --> 00:15:33.240 GDP because if nominal GDP is larger 00:15:31.639 --> 00:15:37.159 then you need to do more transactions 00:15:33.240 --> 00:15:39.480 you need more money more cash ER cash or 00:15:37.159 --> 00:15:41.879 deposit but here we're looking only at 00:15:39.480 --> 00:15:43.879 cash but it's decreasing in the interest 00:15:41.879 --> 00:15:45.559 rate money money is decreasing the Reon 00:15:43.879 --> 00:15:48.159 why it's decreasing in interest rate 00:15:45.559 --> 00:15:50.599 interest rate is the return on the bonds 00:15:48.159 --> 00:15:52.919 no why is money demand decreasing in the 00:15:50.600 --> 00:15:52.920 interest 00:15:55.039 --> 00:15:59.599 rate yeah the opportunity cost of 00:15:57.240 --> 00:16:02.198 holding cash in your pocket is higher 00:15:59.600 --> 00:16:06.240 you didn't care about this 00:16:02.198 --> 00:16:09.519 stuff you know a year ago but now you 00:16:06.240 --> 00:16:13.360 know it cost you 5% to hold cash that's 00:16:09.519 --> 00:16:16.078 what you get in a in a one year 00:16:13.360 --> 00:16:18.639 certificate Bond you treasury bond at 00:16:16.078 --> 00:16:20.078 this moment so it's more significant 00:16:18.639 --> 00:16:22.198 maybe it's not that relevant for you but 00:16:20.078 --> 00:16:23.439 Corporation makes a big difference I 00:16:22.198 --> 00:16:24.958 guarantee you right than keeping the 00:16:23.440 --> 00:16:26.720 thing in the checking account now 00:16:24.958 --> 00:16:29.799 they're really buying short-term 00:16:26.720 --> 00:16:33.319 treasuries and stuff like that okay 00:16:29.799 --> 00:16:37.159 um good so so that's the reason this is 00:16:33.318 --> 00:16:40.879 downward sloping um and 00:16:37.159 --> 00:16:43.958 uh and that's the concept here so then 00:16:40.879 --> 00:16:45.679 what the Central Bank controls is money 00:16:43.958 --> 00:16:48.919 how much money it injects in the economy 00:16:45.679 --> 00:16:50.638 that is how much H you know when okay 00:16:48.919 --> 00:16:53.838 how much money it injects into the 00:16:50.639 --> 00:16:56.759 economy how does let me say just that 00:16:53.839 --> 00:16:58.959 for now and so that's like money supply 00:16:56.759 --> 00:17:01.919 so the equilibrium interest rate is 00:16:58.958 --> 00:17:03.638 simply uh the point in which money 00:17:01.919 --> 00:17:06.318 demand is equal to the money exogenous 00:17:03.639 --> 00:17:08.519 money supply and I said in the modern 00:17:06.318 --> 00:17:10.480 world the central banks don't tell you 00:17:08.519 --> 00:17:12.119 Ms they tell you this is the interest 00:17:10.480 --> 00:17:15.640 rate we want and then they provide 00:17:12.119 --> 00:17:17.479 whatever M they need in order to get the 00:17:15.640 --> 00:17:20.759 interest rate they have told you that 00:17:17.480 --> 00:17:23.038 the they want to have okay so that's the 00:17:20.759 --> 00:17:24.558 case of an expansionary monetary policy 00:17:23.038 --> 00:17:26.759 suppose the FED wants to lower the 00:17:24.558 --> 00:17:30.000 interest rate from here to here well 00:17:26.759 --> 00:17:32.720 what it needs to do is increase money 00:17:30.000 --> 00:17:36.558 and increase money means it goes out 00:17:32.720 --> 00:17:38.839 there and open market operation and and 00:17:36.558 --> 00:17:42.240 and the buys bonds from the private 00:17:38.839 --> 00:17:46.439 sector okay buys bonds takes Bonds in 00:17:42.240 --> 00:17:47.880 and gives them Cash Money okay that's an 00:17:46.440 --> 00:17:50.000 expansion in monetary policy an 00:17:47.880 --> 00:17:52.559 expansionary monetary policy will lower 00:17:50.000 --> 00:17:52.558 the interest 00:17:53.240 --> 00:17:58.640 rate that's an open market operation so 00:17:55.880 --> 00:18:00.200 that's what we just saw was exactly that 00:17:58.640 --> 00:18:02.600 the the FED wants to lower the interest 00:18:00.200 --> 00:18:04.558 rate what it does is it goes out there 00:18:02.599 --> 00:18:06.199 it buys bonds from the private sector so 00:18:04.558 --> 00:18:08.720 it's balance sheet on the asset side has 00:18:06.200 --> 00:18:10.400 more bonds now but it has more 00:18:08.720 --> 00:18:11.600 liabilities because it gives cash to 00:18:10.400 --> 00:18:14.280 people and that's the liability of the 00:18:11.599 --> 00:18:15.879 central banks okay so that's that's an 00:18:14.279 --> 00:18:18.319 open market operation that's an 00:18:15.880 --> 00:18:22.320 expansionary open market operation which 00:18:18.319 --> 00:18:24.599 is designed to lower the interest rate 00:18:22.319 --> 00:18:25.918 okay then I talked about the 00:18:24.599 --> 00:18:28.918 relationship between the interest rate 00:18:25.919 --> 00:18:31.440 and the price of the bond okay and 00:18:28.919 --> 00:18:34.480 that's that's a return on a bond no is 00:18:31.440 --> 00:18:37.679 is is the face value of the bond what 00:18:34.480 --> 00:18:40.440 you get in when the bond matures say 00:18:37.679 --> 00:18:43.320 it's 100 it's a B for 100 minus whatever 00:18:40.440 --> 00:18:47.000 you pay divided by whatever you pay so 00:18:43.319 --> 00:18:49.158 say if you pay today $95 for a bond that 00:18:47.000 --> 00:18:52.279 will pay you $100 a year from now that's 00:18:49.159 --> 00:18:55.520 approximately a 5% interest rate no it's 00:18:52.279 --> 00:18:58.960 a little more but but that's about it 00:18:55.519 --> 00:19:00.519 okay H which is also helps in the 00:18:58.960 --> 00:19:02.720 understand a little bit what what what 00:19:00.519 --> 00:19:04.558 happens during an open market operation 00:19:02.720 --> 00:19:06.400 in an open market operation an expansion 00:19:04.558 --> 00:19:08.000 in monetary policy the Central Bank goes 00:19:06.400 --> 00:19:11.159 out there and buys 00:19:08.000 --> 00:19:13.359 bonds what typically happens to a price 00:19:11.159 --> 00:19:16.120 of a good that is a good or an asset 00:19:13.359 --> 00:19:19.199 that is been bought by somebody big that 00:19:16.119 --> 00:19:20.759 has goes up or down now we have a big 00:19:19.200 --> 00:19:22.080 buyer out there that goes and buys Bond 00:19:20.759 --> 00:19:23.759 do you think the price of bonds will go 00:19:22.079 --> 00:19:27.759 up or 00:19:23.759 --> 00:19:29.400 down up no big guy buyer got into the 00:19:27.759 --> 00:19:32.038 market to buy bonds the price of bonds 00:19:29.400 --> 00:19:34.840 go up but if the P price of bonds goes 00:19:32.038 --> 00:19:37.400 up that means the interest rate goes 00:19:34.839 --> 00:19:38.798 down that's an intuitive way of 00:19:37.400 --> 00:19:41.038 understanding how monetary policy lowers 00:19:38.798 --> 00:19:43.240 interest rate it's a big buyer buying 00:19:41.038 --> 00:19:44.919 bonds the price of bonds will go up but 00:19:43.240 --> 00:19:47.880 the interest rate and the price of the 00:19:44.919 --> 00:19:47.880 bond are inversely 00:19:48.599 --> 00:19:52.839 related you you can see that now suppose 00:19:51.000 --> 00:19:55.599 that the initial price of the bond was 00:19:52.839 --> 00:19:57.839 95 and now the price of the bone goes to 00:19:55.599 --> 00:19:59.678 100 the interest rate goes from a little 00:19:57.839 --> 00:20:02.038 more than 5% to 00:19:59.679 --> 00:20:05.919 zero 00:20:02.038 --> 00:20:08.558 good then I we talk about intermediaries 00:20:05.919 --> 00:20:08.559 forget it for 00:20:09.038 --> 00:20:14.158 now so then we got into two lectures 00:20:11.519 --> 00:20:16.759 about the islm about the basic islm 00:20:14.159 --> 00:20:19.400 model and then we did one more on on the 00:20:16.759 --> 00:20:21.519 extended islm model and I told you that 00:20:19.400 --> 00:20:25.120 at least two third of your quiz will be 00:20:21.519 --> 00:20:26.639 about this so and and I I I already know 00:20:25.119 --> 00:20:29.239 what is in the quiz and I guarantee you 00:20:26.640 --> 00:20:31.559 that I honor my my 00:20:29.240 --> 00:20:35.000 commitment okay so so you better 00:20:31.558 --> 00:20:37.319 understand the slm mod very very well 00:20:35.000 --> 00:20:39.038 now understanding the slm mod also me 00:20:37.319 --> 00:20:42.519 understanding the previous two lectures 00:20:39.038 --> 00:20:45.519 because we're building the islm model 00:20:42.519 --> 00:20:45.519 there 00:20:46.519 --> 00:20:50.480 ER so the first thing we did here is 00:20:49.119 --> 00:20:52.759 said well to make this stuff a little 00:20:50.480 --> 00:20:54.360 more interest we already had a model in 00:20:52.759 --> 00:20:58.319 which we could find equilibrium output 00:20:54.359 --> 00:21:00.879 remember that was in in lecture three we 00:20:58.319 --> 00:21:02.759 had that that but we said but but we 00:21:00.880 --> 00:21:04.720 took many things as exogenous there that 00:21:02.759 --> 00:21:06.839 are really not exogenous in practice in 00:21:04.720 --> 00:21:09.038 particular private investment private 00:21:06.839 --> 00:21:11.278 investment certainly something that 00:21:09.038 --> 00:21:13.079 responds to aggregate activity and to 00:21:11.278 --> 00:21:15.400 the cost of borrowing and things of that 00:21:13.079 --> 00:21:18.119 nature so what we did the first thing we 00:21:15.400 --> 00:21:20.320 did here is we we changed the investment 00:21:18.119 --> 00:21:22.119 function for some constant for something 00:21:20.319 --> 00:21:25.240 that was a function of output and the 00:21:22.119 --> 00:21:26.519 interest rate that component here this 00:21:25.240 --> 00:21:28.679 this the fact that was increasing in 00:21:26.519 --> 00:21:30.759 output just increased the multiplier but 00:21:28.679 --> 00:21:33.320 it didn't change anything 00:21:30.759 --> 00:21:34.599 qualitatively in the analysis but the 00:21:33.319 --> 00:21:38.319 fact that it depends on the interest 00:21:34.599 --> 00:21:40.719 rate is important because now we have as 00:21:38.319 --> 00:21:42.079 a parameter in the in in the goods Mar 00:21:40.720 --> 00:21:45.159 in the aggregate demand curve the 00:21:42.079 --> 00:21:47.000 interest rate okay when you solve out 00:21:45.159 --> 00:21:48.278 the whole thing the interest rate is one 00:21:47.000 --> 00:21:50.480 of the things that can move agregate 00:21:48.278 --> 00:21:52.319 demand around and and and that's 00:21:50.480 --> 00:21:53.599 important because now you can begin to 00:21:52.319 --> 00:21:55.798 see the connection between what the 00:21:53.599 --> 00:21:57.678 Central Bank does and how it affects 00:21:55.798 --> 00:21:59.400 aggregate activity because what the 00:21:57.679 --> 00:22:01.278 Central Bank does affect the interest 00:21:59.400 --> 00:22:03.640 rate the Central Bank cannot go out 00:22:01.278 --> 00:22:05.919 there and buy hamburgers as I said it 00:22:03.640 --> 00:22:08.080 can go out there and buy bonds and with 00:22:05.919 --> 00:22:10.278 that it affects the interest rate and 00:22:08.079 --> 00:22:12.599 and for that to matter for the economy 00:22:10.278 --> 00:22:14.359 not only to bond holders it better be 00:22:12.599 --> 00:22:16.359 the case that that interest rate matters 00:22:14.359 --> 00:22:19.839 for the equilibrium level of output and 00:22:16.359 --> 00:22:21.719 it does so by affecting real investment 00:22:19.839 --> 00:22:25.158 okay so that's a mechanism through which 00:22:21.720 --> 00:22:27.278 monetary policy affect real activity is 00:22:25.159 --> 00:22:29.960 through the cost of 00:22:27.278 --> 00:22:32.200 borrowing we simply in in in reality 00:22:29.960 --> 00:22:34.319 consumers are also affected by that by 00:22:32.200 --> 00:22:36.798 interest rate and so on but the but 00:22:34.319 --> 00:22:38.918 let's keep things simple and have only 00:22:36.798 --> 00:22:41.278 investment as a function of the interest 00:22:38.919 --> 00:22:43.320 rate and and very importantly it's a 00:22:41.278 --> 00:22:45.079 decreasing function of the interest rate 00:22:43.319 --> 00:22:46.839 the higher interest rates the lower is 00:22:45.079 --> 00:22:49.240 investment for any given of output 00:22:46.839 --> 00:22:51.720 because it's more costly to borrow to 00:22:49.240 --> 00:22:55.359 fund that investment so that gave us our 00:22:51.720 --> 00:22:57.159 a curve which is a the combinations of 00:22:55.359 --> 00:22:58.719 output and interest rate that are 00:22:57.159 --> 00:23:00.400 consistent with equilibrium in the 00:22:58.720 --> 00:23:02.759 Market that is when output is equal to 00:23:00.400 --> 00:23:06.038 aggregate demand 00:23:02.759 --> 00:23:11.000 okay so I say yes so that point belongs 00:23:06.038 --> 00:23:14.759 to one is for one interest rate here 00:23:11.000 --> 00:23:18.440 okay so how do we construct the is well 00:23:14.759 --> 00:23:20.278 we start moving the interest rate no so 00:23:18.440 --> 00:23:22.278 uh suppose we start from this this is 00:23:20.278 --> 00:23:24.519 one point in the the point I just showed 00:23:22.278 --> 00:23:27.079 you supposing that we now we increase 00:23:24.519 --> 00:23:29.158 the interest rate we look at the new 00:23:27.079 --> 00:23:31.399 equilibrium output well that Al belongs 00:23:29.159 --> 00:23:33.240 to this is okay and you can keep moving 00:23:31.400 --> 00:23:34.919 the interest rate around so you move ZZ 00:23:33.240 --> 00:23:37.519 around only by moving the interest rate 00:23:34.919 --> 00:23:39.080 don't move g t anything else only by 00:23:37.519 --> 00:23:43.319 moving the interest rate and then you 00:23:39.079 --> 00:23:45.119 can trace an is curve okay if you move 00:23:43.319 --> 00:23:46.720 other parameter than the interest rate 00:23:45.119 --> 00:23:48.278 then it's a move it's a shift in the 00:23:46.720 --> 00:23:51.640 curve it's not a movement along the 00:23:48.278 --> 00:23:53.839 curve so if for example if I increase G 00:23:51.640 --> 00:23:53.840 what 00:23:54.200 --> 00:24:00.360 happens with this 00:23:57.000 --> 00:24:02.319 curve the curve shift to the right okay 00:24:00.359 --> 00:24:05.079 because now for any given level of 00:24:02.319 --> 00:24:07.399 interest rate output will be higher 00:24:05.079 --> 00:24:11.079 because aggregate demand moves up and so 00:24:07.400 --> 00:24:13.400 that's a shift to the right of theare 00:24:11.079 --> 00:24:15.439 good that's an example of the opposite 00:24:13.400 --> 00:24:19.038 is an increasing taxes well it will 00:24:15.440 --> 00:24:19.038 shift the yes to the 00:24:21.038 --> 00:24:25.839 left the L relationship is we already 00:24:23.960 --> 00:24:28.600 described it is is no equilibrium in 00:24:25.839 --> 00:24:31.278 financial markets but we said the way 00:24:28.599 --> 00:24:33.240 monetary policies conducted is the Fed 00:24:31.278 --> 00:24:35.440 sets the interest rate and then money is 00:24:33.240 --> 00:24:37.720 whatever the market needs in order for 00:24:35.440 --> 00:24:41.159 that to be the equilibrium interest rate 00:24:37.720 --> 00:24:43.798 so the mod LM if you will is horizontal 00:24:41.159 --> 00:24:45.799 it's like that okay so now we're set 00:24:43.798 --> 00:24:48.599 because once the FED decides to set this 00:24:45.798 --> 00:24:50.200 interest rate we can find not only the 00:24:48.599 --> 00:24:51.599 equilibrium combinations of interest 00:24:50.200 --> 00:24:53.919 rate and output that are consistent with 00:24:51.599 --> 00:24:56.079 equilibrium in the Goods Market but the 00:24:53.919 --> 00:24:58.120 particular equilibrium level of output 00:24:56.079 --> 00:24:59.398 that is consistent with that interest 00:24:58.119 --> 00:25:01.918 rate 00:24:59.398 --> 00:25:05.479 and that's exactly equilibrium out okay 00:25:01.919 --> 00:25:07.600 so given the LM now I looked at 00:25:05.480 --> 00:25:09.319 intersection with my is and that gives 00:25:07.599 --> 00:25:10.759 me equilibrium output for that level of 00:25:09.319 --> 00:25:14.038 the interest rate which has been set by 00:25:10.759 --> 00:25:14.038 the FED 00:25:14.839 --> 00:25:19.119 okay and then you can use this model 00:25:17.038 --> 00:25:20.960 this is a very powerful little model 00:25:19.119 --> 00:25:24.038 because now you can do lots of things 00:25:20.960 --> 00:25:25.960 with it no for example H that's a 00:25:24.038 --> 00:25:28.359 contractionary fiscal policy that's what 00:25:25.960 --> 00:25:31.079 happens when you reduce G or when you 00:25:28.359 --> 00:25:31.079 you increase 00:25:33.038 --> 00:25:42.119 T what happens if you reduce 00:25:37.480 --> 00:25:42.120 G and T by the same 00:25:44.919 --> 00:25:50.120 amount you see what I'm doing and maybe 00:25:48.079 --> 00:25:51.480 if you that that's often done is okay 00:25:50.119 --> 00:25:53.599 you can increase govern expend but then 00:25:51.480 --> 00:25:56.440 you find a source of Revenue or or or 00:25:53.599 --> 00:25:58.599 reduced govern expenditure but 00:25:56.440 --> 00:26:00.759 then you don't need to generate fiscal 00:25:58.599 --> 00:26:01.519 Surplus so on so when I'm saying this is 00:26:00.759 --> 00:26:04.319 a 00:26:01.519 --> 00:26:06.398 Balan Balan budget fiscal policy that's 00:26:04.319 --> 00:26:11.079 what it's called okay what if I move G 00:26:06.398 --> 00:26:11.079 and T by the same amount does that curve 00:26:14.000 --> 00:26:20.119 move 00:26:16.440 --> 00:26:22.960 yeah because the multip next to T is c0 00:26:20.119 --> 00:26:29.038 in the equation original equation so 00:26:22.960 --> 00:26:32.960 c0 C1 okay perfect yeah yeah so in which 00:26:29.038 --> 00:26:37.278 direction does it move so if I reduce 00:26:32.960 --> 00:26:39.720 G and reduce T by the same amount what 00:26:37.278 --> 00:26:41.000 happens to the I moves to the left or to 00:26:39.720 --> 00:26:43.720 the 00:26:41.000 --> 00:26:45.798 right yeah it moves to the left left 00:26:43.720 --> 00:26:48.558 because why is that I can always go back 00:26:45.798 --> 00:26:50.879 to my basic Goods market equilibrium mod 00:26:48.558 --> 00:26:53.200 if I reduce G by one that reduces 00:26:50.880 --> 00:26:55.760 aggregate demand one by one one for one 00:26:53.200 --> 00:26:58.360 and then the multiplier sort of kicks in 00:26:55.759 --> 00:27:03.119 if I REM but the initial change shift 00:26:58.359 --> 00:27:06.558 down is one if I if I reduce 00:27:03.119 --> 00:27:11.959 taxes I increase aggregate demand but by 00:27:06.558 --> 00:27:14.879 C1 times one no and so I had a reduction 00:27:11.960 --> 00:27:18.200 in a demand of one and I had an increas 00:27:14.880 --> 00:27:20.159 in aggre demand of C1 1 minus C1 is 00:27:18.200 --> 00:27:26.640 greater than zero that's the reason you 00:27:20.159 --> 00:27:26.640 have a net a reduction in in agre demand 00:27:29.278 --> 00:27:37.599 hint this is not a random thought I have 00:27:32.038 --> 00:27:37.599 okay so so do understand it okay 00:27:39.038 --> 00:27:42.038 good 00:27:43.960 --> 00:27:51.679 okay that's monetary 00:27:46.200 --> 00:27:55.000 policy ER so um we that's an expansion 00:27:51.679 --> 00:27:57.559 in monetary policy and in equilibrium 00:27:55.000 --> 00:27:58.919 why is spary so cutting interest rate 00:27:57.558 --> 00:28:01.079 course it will increase equilibrium 00:27:58.919 --> 00:28:03.519 output that's a case in 00:28:01.079 --> 00:28:04.960 which the FED probably is unhappy with 00:28:03.519 --> 00:28:07.200 this low level of output maybe it's a 00:28:04.960 --> 00:28:08.880 recession so one of the main policy 00:28:07.200 --> 00:28:10.798 tools we have to fight a recession is to 00:28:08.880 --> 00:28:12.760 lower the interest rate and you can see 00:28:10.798 --> 00:28:15.158 here how lowering the interest rate will 00:28:12.759 --> 00:28:17.558 increase equilibrium output how does it 00:28:15.159 --> 00:28:20.559 happen why is it that this happen why is 00:28:17.558 --> 00:28:20.558 it that equilibrium output 00:28:22.640 --> 00:28:27.799 Rises exactly it's because increasing 00:28:25.398 --> 00:28:30.518 investment that gives us the first kick 00:28:27.798 --> 00:28:32.240 and once equilibrium starts Rising then 00:28:30.519 --> 00:28:33.839 consumption Rises and we get the whole 00:28:32.240 --> 00:28:36.399 the whole multiply but the initial 00:28:33.839 --> 00:28:39.398 impulse is exactly because there 00:28:36.398 --> 00:28:39.398 increase in in in 00:28:39.919 --> 00:28:44.840 investment H how does it Implement that 00:28:43.079 --> 00:28:46.398 open market operation so what the FED 00:28:44.839 --> 00:28:49.199 will do if it wants to cut the interest 00:28:46.398 --> 00:28:52.678 rate it goes out there buys bonds from 00:28:49.200 --> 00:28:56.319 the public and gives him money in 00:28:52.679 --> 00:28:58.720 exchange okay and that's what happens 00:28:56.319 --> 00:29:00.599 here and then I talk about different 00:28:58.720 --> 00:29:02.440 policy mixes no this this is what 00:29:00.599 --> 00:29:05.079 typically when an economy is deep into 00:29:02.440 --> 00:29:06.720 recession you're going to see both 00:29:05.079 --> 00:29:08.319 policies that work at the same time 00:29:06.720 --> 00:29:10.480 that's very powerful that's a case in 00:29:08.319 --> 00:29:14.158 which in 00:29:10.480 --> 00:29:15.640 which you know we have a very we cut we 00:29:14.159 --> 00:29:17.519 have an expansionary monetary policy 00:29:15.640 --> 00:29:20.399 that shift is down and an expansionary 00:29:17.519 --> 00:29:22.399 fiscal policy and uh you know that's 00:29:20.398 --> 00:29:24.518 definitely what we did during covid was 00:29:22.398 --> 00:29:26.719 massive and during the global financial 00:29:24.519 --> 00:29:29.278 crisis so typically big recessions will 00:29:26.720 --> 00:29:30.880 lead to any recession will lead to 00:29:29.278 --> 00:29:32.319 something like that obviously if it is 00:29:30.880 --> 00:29:35.120 Big you're going to have to a bigger 00:29:32.319 --> 00:29:37.759 combination of this kind of 00:29:35.119 --> 00:29:40.038 stuff some problems that that monetary 00:29:37.759 --> 00:29:42.480 policy May face is that you know 00:29:40.038 --> 00:29:43.919 sometimes you hit a Zer lower bound and 00:29:42.480 --> 00:29:45.319 then when you hit a zero lower bound is 00:29:43.919 --> 00:29:47.640 you just can't lower the interest rate 00:29:45.319 --> 00:29:49.519 more you lose monetary policy you need 00:29:47.640 --> 00:29:52.759 to do other stuff and typically fiscal 00:29:49.519 --> 00:29:55.038 policy then becomes very very active 00:29:52.759 --> 00:29:57.000 okay and this is not just a the 00:29:55.038 --> 00:30:00.038 theoretical curiosity I mean we have 00:29:57.000 --> 00:30:02.919 been against zero lower Bound for a 00:30:00.038 --> 00:30:05.720 sustain amount of time during the last 00:30:02.919 --> 00:30:05.720 20 years or 00:30:06.440 --> 00:30:12.360 so oh that's another policy mix as well 00:30:10.398 --> 00:30:15.038 that suppose that you need to do a 00:30:12.359 --> 00:30:18.398 fiscal adjustment I said so you want to 00:30:15.038 --> 00:30:20.278 reduce the deficit reduce G but you 00:30:18.398 --> 00:30:22.759 don't want to have a recession as a 00:30:20.278 --> 00:30:25.319 result of that one way you can do that 00:30:22.759 --> 00:30:27.960 is by you know you have a a contraction 00:30:25.319 --> 00:30:29.960 in G or increase in taxes that's contra 00:30:27.960 --> 00:30:32.000 actionary but you can offset it with an 00:30:29.960 --> 00:30:33.600 expansion in monetary policy I think in 00:30:32.000 --> 00:30:35.759 the quiz somewhere you have a question 00:30:33.599 --> 00:30:37.599 not I don't think there specific to this 00:30:35.759 --> 00:30:38.919 but in which you're asked to compensate 00:30:37.599 --> 00:30:41.398 for something with something and 00:30:38.919 --> 00:30:44.480 something like that okay so some curve 00:30:41.398 --> 00:30:47.839 move and then you are asked to offset 00:30:44.480 --> 00:30:49.839 that effect on output okay so you should 00:30:47.839 --> 00:30:53.240 understand these kind of things The Next 00:30:49.839 --> 00:30:57.678 Step was to extend a little bit our eslm 00:30:53.240 --> 00:31:01.519 model and by extension we said well look 00:30:57.679 --> 00:31:04.399 at this moment we have only a um prices 00:31:01.519 --> 00:31:06.399 are completely fixed but in reality we 00:31:04.398 --> 00:31:08.199 have inflation and so the nominal 00:31:06.398 --> 00:31:09.918 interest rate is not really the 00:31:08.200 --> 00:31:11.960 effective cost of capital for a company 00:31:09.919 --> 00:31:14.000 a company that wants to fund a real 00:31:11.960 --> 00:31:15.399 investment is more concerned with the 00:31:14.000 --> 00:31:17.440 real interest rate is pain not the 00:31:15.398 --> 00:31:19.839 nominal interest rate so with prices 00:31:17.440 --> 00:31:21.880 that are constant There's no distinction 00:31:19.839 --> 00:31:23.879 but if you have positive inflation then 00:31:21.880 --> 00:31:25.559 then then the distinction makes a makes 00:31:23.880 --> 00:31:27.360 a difference that's the reason we wanted 00:31:25.558 --> 00:31:30.319 to talk about that and the second thing 00:31:27.359 --> 00:31:32.000 is that the same firms are are very 00:31:30.319 --> 00:31:35.398 unlikely to pay the same that the 00:31:32.000 --> 00:31:37.519 treasury pays for borrowing pay it's a 00:31:35.398 --> 00:31:39.518 risky proposition to invest in bonds 00:31:37.519 --> 00:31:40.519 issued by a corporation and therefore 00:31:39.519 --> 00:31:43.278 they're going to have to pay a risk 00:31:40.519 --> 00:31:47.638 premium for that okay and so the 00:31:43.278 --> 00:31:49.960 importance of these two things is that 00:31:47.638 --> 00:31:53.359 ER we ended 00:31:49.960 --> 00:31:55.600 up with an islm M that have now had 00:31:53.359 --> 00:31:57.278 something a little more complicated here 00:31:55.599 --> 00:31:59.719 because it didn't have only the nominal 00:31:57.278 --> 00:32:02.519 interest rate but also had expected 00:31:59.720 --> 00:32:06.120 inflation if for any given nominal 00:32:02.519 --> 00:32:07.880 interest rate if if uh we expect a 00:32:06.119 --> 00:32:12.000 higher inflation that means a lower real 00:32:07.880 --> 00:32:13.559 interest rate okay so so for any given 00:32:12.000 --> 00:32:15.558 nominal interest rate if expected 00:32:13.558 --> 00:32:17.759 inflation goes up that's expansionary 00:32:15.558 --> 00:32:20.599 really for firms okay it's like it's 00:32:17.759 --> 00:32:23.278 cheaper in a sense to borrow okay 00:32:20.599 --> 00:32:25.879 conversely if x goes up the great spread 00:32:23.278 --> 00:32:27.599 goes up that's contractionary because 00:32:25.880 --> 00:32:32.880 it's now more expensive for the firms to 00:32:27.599 --> 00:32:38.759 borrow for any given real interest rate 00:32:32.880 --> 00:32:41.440 okay so we can we can this is called 00:32:38.759 --> 00:32:43.879 extended islm model simply because it 00:32:41.440 --> 00:32:47.120 has been extended to incorporate this 00:32:43.880 --> 00:32:49.120 these add additional factors and now you 00:32:47.119 --> 00:32:51.038 have two more parameters in your in your 00:32:49.119 --> 00:32:55.038 model which is expected inflation and 00:32:51.038 --> 00:32:56.480 the credit spreads okay so if you move 00:32:55.038 --> 00:32:58.839 either of 00:32:56.480 --> 00:33:00.278 these you're going to going to move your 00:32:58.839 --> 00:33:03.278 aggregate demand curve in the Goods 00:33:00.278 --> 00:33:05.159 Market no and it's going to move for 00:33:03.278 --> 00:33:07.278 exactly the same reasons that that 00:33:05.159 --> 00:33:10.240 aggregate demand move when you move the 00:33:07.278 --> 00:33:12.960 interest rate it enters symmetrically in 00:33:10.240 --> 00:33:14.759 this model these guys here enter 00:33:12.960 --> 00:33:17.240 completely symmetrically with then the 00:33:14.759 --> 00:33:18.960 interest rate so whatever was the 00:33:17.240 --> 00:33:21.319 comparative Statics you had with respect 00:33:18.960 --> 00:33:25.558 to the nominal interest rate before they 00:33:21.319 --> 00:33:28.439 appli to x minus 00:33:25.558 --> 00:33:31.599 Pi what I'm trying to say is 00:33:28.440 --> 00:33:34.240 if I if you know how what is the change 00:33:31.599 --> 00:33:35.918 in equilibrium output as a response as a 00:33:34.240 --> 00:33:38.159 result of an increase in 100 basis 00:33:35.919 --> 00:33:39.519 points on the nominal interest rate then 00:33:38.159 --> 00:33:41.360 you know what is a response of 00:33:39.519 --> 00:33:44.000 equilibrium output to an increasing 00:33:41.359 --> 00:33:46.798 credit spreads of 100 basis points or to 00:33:44.000 --> 00:33:49.000 a reduction or or to a reduction in 00:33:46.798 --> 00:33:50.119 expected inflation of 100 basis points 00:33:49.000 --> 00:33:53.359 the entire 00:33:50.119 --> 00:33:55.719 symmetric okay because that's a that's a 00:33:53.359 --> 00:33:59.558 channel is the it's the real it's a cost 00:33:55.720 --> 00:34:01.120 of capital Channel you know for the firm 00:33:59.558 --> 00:34:03.720 that's they're all entering exactly 00:34:01.119 --> 00:34:06.359 through the same the same place but the 00:34:03.720 --> 00:34:07.798 but the the FED doesn't control this guy 00:34:06.359 --> 00:34:11.519 it controls only the nominal interest 00:34:07.798 --> 00:34:14.159 rate okay so anyways so these are new 00:34:11.519 --> 00:34:17.960 parameters here so this is an example 00:34:14.159 --> 00:34:20.800 here that's an example in which credit 00:34:17.960 --> 00:34:25.519 spreads or respected inflation went 00:34:20.800 --> 00:34:29.720 up sorry whether CR spreads went down or 00:34:25.519 --> 00:34:31.119 expected inflation went up up okay and 00:34:29.719 --> 00:34:33.878 that's expansionary that will increase 00:34:31.119 --> 00:34:36.679 aggregate demand because for any given 00:34:33.878 --> 00:34:40.559 level of output now there will be more 00:34:36.679 --> 00:34:42.440 investment okay cre spreads are lower or 00:34:40.559 --> 00:34:43.719 expected inflation is higher mean the 00:34:42.440 --> 00:34:46.119 real interest rate is lower for any 00:34:43.719 --> 00:34:48.519 given nominal interest rate so if the if 00:34:46.119 --> 00:34:51.639 if the FED doesn't react to that that's 00:34:48.519 --> 00:34:51.639 going to lead to an expansion in 00:34:52.719 --> 00:34:57.439 output of course the FED could react to 00:34:55.119 --> 00:34:59.960 that suppose the FED is okay with the 00:34:57.440 --> 00:35:02.760 level of output we 00:34:59.960 --> 00:35:05.800 have okay suppose it's a level of output 00:35:02.760 --> 00:35:07.599 and the F seeing credit spreads falling 00:35:05.800 --> 00:35:09.640 so output is expanding but the FED says 00:35:07.599 --> 00:35:12.160 no no no the level of output y z was 00:35:09.639 --> 00:35:13.799 what I needed I don't want y1 what would 00:35:12.159 --> 00:35:17.199 the FED 00:35:13.800 --> 00:35:18.920 do increase the interest rate exactly 00:35:17.199 --> 00:35:21.519 and it's very easy to see in this 00:35:18.920 --> 00:35:23.680 expression here that that if you don't 00:35:21.519 --> 00:35:26.320 want this guy the total sum to move then 00:35:23.679 --> 00:35:30.358 if this guy moves down or or this guy 00:35:26.320 --> 00:35:32.119 moves up then I need to move I exactly 00:35:30.358 --> 00:35:33.400 to offset that and that's it it's very 00:35:32.119 --> 00:35:35.680 easy to calculate I don't need to solve 00:35:33.400 --> 00:35:37.680 my whole model actually you know you 00:35:35.679 --> 00:35:39.399 tell me this thing in net went down by 00:35:37.679 --> 00:35:41.000 100 basis points if I don't want to 00:35:39.400 --> 00:35:42.599 change output then I need to increase 00:35:41.000 --> 00:35:45.079 the interest rate by 100 basis points so 00:35:42.599 --> 00:35:46.760 I don't change the cost of borrowing the 00:35:45.079 --> 00:35:49.560 effective cost of borrowing for 00:35:46.760 --> 00:35:51.760 corporations 00:35:49.559 --> 00:35:55.318 okay in fact this is exactly what is 00:35:51.760 --> 00:35:57.839 going on right now in the US economy you 00:35:55.318 --> 00:35:59.358 know every time markets get very excited 00:35:57.838 --> 00:36:01.199 credit specs are compressed the stock 00:35:59.358 --> 00:36:03.000 market goes up the FED comes out and say 00:36:01.199 --> 00:36:05.639 come on guys I mean we have inflation 00:36:03.000 --> 00:36:07.280 problem I'm going to need to keep hiking 00:36:05.639 --> 00:36:10.118 interest rates 00:36:07.280 --> 00:36:12.119 because I need to offset Your 00:36:10.119 --> 00:36:14.160 Enthusiasm they don't use those words 00:36:12.119 --> 00:36:16.800 but that's exactly what happened I mean 00:36:14.159 --> 00:36:18.679 chairman pow was testifying in Congress 00:36:16.800 --> 00:36:21.079 yesterday and today and that's what he 00:36:18.679 --> 00:36:24.919 said I me just giving you a summary of 00:36:21.079 --> 00:36:24.920 what he said okay 00:36:29.000 --> 00:36:32.119 now a problem that the Central Bank May 00:36:30.679 --> 00:36:34.679 face suppose you have the opposite 00:36:32.119 --> 00:36:36.838 situation is that one in which credit 00:36:34.679 --> 00:36:39.318 spreads are going up a lot and expected 00:36:36.838 --> 00:36:40.920 inflation is declining a lot and the FED 00:36:39.318 --> 00:36:42.639 doesn't want output to the client 00:36:40.920 --> 00:36:44.680 because that combination will lead to 00:36:42.639 --> 00:36:48.519 reduction in output so the FED wants to 00:36:44.679 --> 00:36:48.519 cut interest rate what problem may it 00:36:49.358 --> 00:36:54.519 face it's zero lower bound it may not be 00:36:52.159 --> 00:36:56.879 able to bring interest rate as much as 00:36:54.519 --> 00:37:00.239 because suppose that the the interest 00:36:56.880 --> 00:37:02.358 rate today is is a is a 50 basis point 00:37:00.239 --> 00:37:06.919 it's not the case today but it was two 00:37:02.358 --> 00:37:09.400 years ago 50 basis point 25 basis points 00:37:06.920 --> 00:37:11.599 and cre spreads go up by 200 basis 00:37:09.400 --> 00:37:14.680 points well there's no way the FED can 00:37:11.599 --> 00:37:17.039 upset that no because he has maximum 25 00:37:14.679 --> 00:37:18.719 basis points to lower and cre the spread 00:37:17.039 --> 00:37:20.400 went up by 100 basis points and that's 00:37:18.719 --> 00:37:22.799 when you start seeing all these more 00:37:20.400 --> 00:37:25.200 exotic policies quantitive eing and 00:37:22.800 --> 00:37:26.680 other things to offset the negative 00:37:25.199 --> 00:37:29.039 impact of the of the increase in the 00:37:26.679 --> 00:37:31.799 greater spreads in the 00:37:29.039 --> 00:37:34.759 economy and the last thing we we did was 00:37:31.800 --> 00:37:39.039 to begin a 00:37:34.760 --> 00:37:41.200 a our transitions to medium run issues 00:37:39.039 --> 00:37:43.079 and and the whole thing began from the 00:37:41.199 --> 00:37:44.399 labor market now you're going to get a 00:37:43.079 --> 00:37:46.039 little bit in the quiz of that but it's 00:37:44.400 --> 00:37:47.519 not going to be as important as what I 00:37:46.039 --> 00:37:48.639 just described but a little bit you're 00:37:47.519 --> 00:37:52.920 going to 00:37:48.639 --> 00:37:55.039 have and the basic uh well definitions 00:37:52.920 --> 00:37:58.119 you should should know the basic 00:37:55.039 --> 00:38:00.119 definitions well this was the first a a 00:37:58.119 --> 00:38:02.640 important equation we have a a wage 00:38:00.119 --> 00:38:05.119 setting equation that says essentially 00:38:02.639 --> 00:38:06.799 that wages are increasing in expected 00:38:05.119 --> 00:38:08.039 prices obviously the nominal wage the 00:38:06.800 --> 00:38:10.079 workers are going to demand is going to 00:38:08.039 --> 00:38:13.159 be higher if they expect the price level 00:38:10.079 --> 00:38:15.440 to be higher in the future but important 00:38:13.159 --> 00:38:17.759 is decreasing in unemployment and 00:38:15.440 --> 00:38:19.280 increasing in this in this variable that 00:38:17.760 --> 00:38:23.400 represents sort of their bargaining 00:38:19.280 --> 00:38:24.880 power and so on H then we look at what 00:38:23.400 --> 00:38:27.720 happened on the on the product on the 00:38:24.880 --> 00:38:28.960 price setting side meaning what firms do 00:38:27.719 --> 00:38:30.759 and for that we had to start with the 00:38:28.960 --> 00:38:32.119 production function we had a very simple 00:38:30.760 --> 00:38:33.599 production function which said if you 00:38:32.119 --> 00:38:36.200 want to produce one more unit of the 00:38:33.599 --> 00:38:37.640 good you need to have one more worker 00:38:36.199 --> 00:38:39.598 that means that the marginal cost of 00:38:37.639 --> 00:38:41.519 production is the wage so it's very 00:38:39.599 --> 00:38:43.559 simple and then we said we're going to 00:38:41.519 --> 00:38:46.199 have a very simple model in which the 00:38:43.559 --> 00:38:48.920 the firms charge their marginal cost 00:38:46.199 --> 00:38:52.118 which is the wage times a marup 1 plus M 00:38:48.920 --> 00:38:54.639 so m is a number like say2 okay so if 00:38:52.119 --> 00:38:57.240 the wage is 100 the markup is 20% they 00:38:54.639 --> 00:39:00.440 want the price of they're want to charge 00:38:57.239 --> 00:39:03.439 a price of 120 we can rearrange this in 00:39:00.440 --> 00:39:05.760 terms of wages and you can say well the 00:39:03.440 --> 00:39:07.760 firm the maximum real wage that firms 00:39:05.760 --> 00:39:10.319 collectively are willing to pay is 00:39:07.760 --> 00:39:15.040 really one over one plus the market okay 00:39:10.318 --> 00:39:16.838 that's just from that so then we look at 00:39:15.039 --> 00:39:18.599 a concept that that is important which 00:39:16.838 --> 00:39:20.639 is the natural rate of unemployment and 00:39:18.599 --> 00:39:24.000 we said the natural rate of unemployment 00:39:20.639 --> 00:39:26.960 has nothing of natural it just means 00:39:24.000 --> 00:39:29.318 that is the level of unemployment when 00:39:26.960 --> 00:39:30.880 the price is equal to expected price or 00:39:29.318 --> 00:39:34.079 expected price equal to the price you 00:39:30.880 --> 00:39:35.720 pick okay so all that we did was to 00:39:34.079 --> 00:39:37.839 replacing the weight setting equation 00:39:35.719 --> 00:39:40.239 the expected price for the actual price 00:39:37.838 --> 00:39:42.799 and then we divided both sides and now 00:39:40.239 --> 00:39:44.799 we have this real wage Demand by by 00:39:42.800 --> 00:39:46.839 workers when the price is equal to 00:39:44.800 --> 00:39:49.400 expected price and we also had a price 00:39:46.838 --> 00:39:53.078 set in equation we can and I said when 00:39:49.400 --> 00:39:56.000 we replace P for p then I get the right 00:39:53.079 --> 00:39:57.560 to put an n superscript n there that's 00:39:56.000 --> 00:39:58.838 the natural rate of unemployment because 00:39:57.559 --> 00:40:01.039 that's my definition of the natural rate 00:39:58.838 --> 00:40:03.679 ofemployment what happens when I can 00:40:01.039 --> 00:40:07.039 replace in the weight setting equation H 00:40:03.679 --> 00:40:08.639 the the expected price for the price and 00:40:07.039 --> 00:40:10.400 we look at the at the natural rate of 00:40:08.639 --> 00:40:13.559 unemployment what is equilibrium here of 00:40:10.400 --> 00:40:16.079 the price setting equation has an imply 00:40:13.559 --> 00:40:18.679 real wage of 1 over 1 plus M and that's 00:40:16.079 --> 00:40:20.119 a wage setting equation which is 00:40:18.679 --> 00:40:21.440 obviously decreasing unemployment 00:40:20.119 --> 00:40:23.358 because the higher is unemployment the 00:40:21.440 --> 00:40:25.960 lower the wage Demand by the workers 00:40:23.358 --> 00:40:27.838 okay and that's one natural rate of 00:40:25.960 --> 00:40:30.079 unemployment again nothing natural is a 00:40:27.838 --> 00:40:31.480 function of parameters which parameters 00:40:30.079 --> 00:40:33.280 well it's a function of that markup 00:40:31.480 --> 00:40:36.719 parameter it's a function of this 00:40:33.280 --> 00:40:40.280 institutional variable Z for example 00:40:36.719 --> 00:40:41.559 okay so that's in equations that's an 00:40:40.280 --> 00:40:45.359 example in 00:40:41.559 --> 00:40:47.960 which Z goes up so suppose that somehow 00:40:45.358 --> 00:40:49.799 you know unions go up or something like 00:40:47.960 --> 00:40:52.960 unionization goes up something of that 00:40:49.800 --> 00:40:54.640 kind or an employment benefits go up 00:40:52.960 --> 00:40:56.519 something of that kind which in in 00:40:54.639 --> 00:40:58.039 principle is supportive of workers well 00:40:56.519 --> 00:40:59.440 in this model 00:40:58.039 --> 00:41:02.119 that will immediately lead to an 00:40:59.440 --> 00:41:04.880 increasing wage demand for at this level 00:41:02.119 --> 00:41:05.960 of unemployment there going to be a a 00:41:04.880 --> 00:41:08.559 higher 00:41:05.960 --> 00:41:09.800 demand higher real wage Demand by the 00:41:08.559 --> 00:41:12.599 workers because they have more 00:41:09.800 --> 00:41:15.400 bargaining power now in this particular 00:41:12.599 --> 00:41:17.680 model that that cannot happen because 00:41:15.400 --> 00:41:20.358 the real wage that firms can are willing 00:41:17.679 --> 00:41:22.480 to pay is only this one one plus M so in 00:41:20.358 --> 00:41:24.598 order to restore equilibrium in the in 00:41:22.480 --> 00:41:26.119 the labor market what has to happen is 00:41:24.599 --> 00:41:27.760 unemployment natural rate of 00:41:26.119 --> 00:41:29.160 unemployment will go up 00:41:27.760 --> 00:41:31.800 and and that that will restore 00:41:29.159 --> 00:41:33.639 equilibrium here because well workers 00:41:31.800 --> 00:41:36.079 the the the bargaining power workers 00:41:33.639 --> 00:41:39.519 gain through those benefits in Z they 00:41:36.079 --> 00:41:41.599 end up losing by an increas in the 00:41:39.519 --> 00:41:42.599 equilibrium level of unemployment okay 00:41:41.599 --> 00:41:45.800 so that's the 00:41:42.599 --> 00:41:47.599 reason hear this stuff backfiring as to 00:41:45.800 --> 00:41:49.920 the workers because you know you end up 00:41:47.599 --> 00:41:51.838 with higher natural rate of unemployment 00:41:49.920 --> 00:41:53.720 so Europe for example has much higher 00:41:51.838 --> 00:41:55.559 labor protection than the US well they 00:41:53.719 --> 00:41:57.919 typically have a much higher 00:41:55.559 --> 00:41:59.920 unemployment rate than the US okay so 00:41:57.920 --> 00:42:02.280 that tradeoffs all these 00:41:59.920 --> 00:42:04.639 things that's a case of increaseing the 00:42:02.280 --> 00:42:07.720 markup and increasing the markup means 00:42:04.639 --> 00:42:10.279 effectively that the firms are going 00:42:07.719 --> 00:42:11.919 offering a lower real wage well at this 00:42:10.280 --> 00:42:14.119 level of unemployment workers are not 00:42:11.920 --> 00:42:15.800 going to take that lower real wage so 00:42:14.119 --> 00:42:18.079 what will have to happen for workers to 00:42:15.800 --> 00:42:20.039 take that low lower real wage is for 00:42:18.079 --> 00:42:21.680 unemployment to rise okay so those are 00:42:20.039 --> 00:42:23.639 the two canonical experiments you can 00:42:21.679 --> 00:42:26.440 have here it's what happens when markets 00:42:23.639 --> 00:42:30.039 go up and that can go they can go up for 00:42:26.440 --> 00:42:31.760 for the wrong reason it could be for oil 00:42:30.039 --> 00:42:33.279 shocks and stuff like that it could be 00:42:31.760 --> 00:42:36.160 because the market becomes less 00:42:33.280 --> 00:42:38.640 competitive allistic firms and so on but 00:42:36.159 --> 00:42:39.759 the final outcome here is that we end up 00:42:38.639 --> 00:42:42.000 with a higher natural rate of 00:42:39.760 --> 00:42:43.640 unemployment which again highlights the 00:42:42.000 --> 00:42:46.199 idea that this is not a g given 00:42:43.639 --> 00:42:47.799 unemployment rate so it's not it's not 00:42:46.199 --> 00:42:50.439 good in any sense it's it's just 00:42:47.800 --> 00:42:50.440 whatever it is the 00:42:51.440 --> 00:42:56.200 equilibri okay uh anyway so you should 00:42:54.719 --> 00:42:59.159 understand well what these two type of 00:42:56.199 --> 00:43:02.000 shocks do to the natur rate of 00:42:59.159 --> 00:43:06.159 unemployment I think that's because then 00:43:02.000 --> 00:43:06.159 lecture nine is not for this this 00:43:06.400 --> 00:43:11.119 quiz that's all I want to say any any 00:43:13.000 --> 00:43:16.000 questions 00:43:21.800 --> 00:43:24.800 no 00:43:25.079 --> 00:43:33.680 y this I think so I think is that the 00:43:28.559 --> 00:43:37.559 same a as next to the yeah this is the 00:43:33.679 --> 00:43:41.000 C you you want me to explain this this 00:43:37.559 --> 00:43:42.760 this yeah yeah it is a CR spread I said 00:43:41.000 --> 00:43:45.599 that's the way you calculate this CR 00:43:42.760 --> 00:43:50.440 spread here it's um remember there are 00:43:45.599 --> 00:43:50.440 two reasons why why 00:43:51.280 --> 00:43:59.000 um do you really want to 00:43:54.760 --> 00:44:00.760 know in anyway let me let me say so 00:43:59.000 --> 00:44:03.559 there are two reasons why the credit 00:44:00.760 --> 00:44:06.160 Express really happen one is the actual 00:44:03.559 --> 00:44:08.040 probability of the fault of a bond which 00:44:06.159 --> 00:44:09.519 the treasury has a very low priority def 00:44:08.039 --> 00:44:11.759 fall corporations depending on the 00:44:09.519 --> 00:44:13.119 ratings they may have higher or lower 00:44:11.760 --> 00:44:15.559 and the other one which is very 00:44:13.119 --> 00:44:18.318 significant is how risk averse investors 00:44:15.559 --> 00:44:21.440 are and that risk aversion changes a lot 00:44:18.318 --> 00:44:23.480 over the business cycle H we capture 00:44:21.440 --> 00:44:25.440 everything through just that X spread 00:44:23.480 --> 00:44:27.199 which we we capture it through this 00:44:25.440 --> 00:44:28.679 probability of theault but you can think 00:44:27.199 --> 00:44:30.439 that prity of the fault as being the 00:44:28.679 --> 00:44:31.879 perceived priority of the fault and when 00:44:30.440 --> 00:44:34.800 you're very scared you perceive that 00:44:31.880 --> 00:44:36.640 terrible things can happen so so it's a 00:44:34.800 --> 00:44:39.359 subjective priority of the 00:44:36.639 --> 00:44:40.799 fault so when that priority of the fault 00:44:39.358 --> 00:44:42.759 is different from zero then you start 00:44:40.800 --> 00:44:45.839 getting a positive 00:44:42.760 --> 00:44:48.720 spread how impactful is the actual def I 00:44:45.838 --> 00:44:50.358 know there were some recent defaults in 00:44:48.719 --> 00:44:53.279 at least the European like real estate 00:44:50.358 --> 00:44:55.799 markets yeah um like how I guess is 00:44:53.280 --> 00:44:57.839 there a difference between like a fear 00:44:55.800 --> 00:45:00.240 of a default and like an actual 00:44:57.838 --> 00:45:02.239 implications as oh this is all about 00:45:00.239 --> 00:45:05.159 perceived risk so it's because this is 00:45:02.239 --> 00:45:06.959 this determines the the borrowing that 00:45:05.159 --> 00:45:09.000 firms can do the cost for firms of 00:45:06.960 --> 00:45:11.039 borrowing if you already defaulted you 00:45:09.000 --> 00:45:12.838 cannot borrow so that's that's over that 00:45:11.039 --> 00:45:14.920 that has other consequences it may have 00:45:12.838 --> 00:45:17.078 impact on the balance sheet of the banks 00:45:14.920 --> 00:45:19.280 it's destruction of wealth it may lead 00:45:17.079 --> 00:45:20.599 to other problems but the problem we're 00:45:19.280 --> 00:45:22.319 highlighting here in this model is the 00:45:20.599 --> 00:45:26.680 cost of borrowing and that is something 00:45:22.318 --> 00:45:26.679 that happens only before you default 00:45:28.920 --> 00:45:33.880 yeah I mean actual defaults especially 00:45:32.239 --> 00:45:35.679 typically in developers and stuff like 00:45:33.880 --> 00:45:39.039 that can and that's what happen in the 00:45:35.679 --> 00:45:40.358 Great Recession ER can have consequences 00:45:39.039 --> 00:45:42.639 especially for the 00:45:40.358 --> 00:45:45.799 banks that typically lend to this 00:45:42.639 --> 00:45:47.679 developers and so on but I I may do 00:45:45.800 --> 00:45:51.000 something about financial crisis but 00:45:47.679 --> 00:45:52.558 much later in the course at the end okay 00:45:51.000 --> 00:45:55.079 well good luck enjoy it if you 00:45:52.559 --> 00:45:59.960 understood what I said today you're 00:45:55.079 --> 00:45:59.960 you're in good shape for