WEBVTT 00:00:17.640 --> 00:00:26.560 all right let's uh let's start um so 00:00:23.359 --> 00:00:29.720 today I want to talk about uh interest 00:00:26.559 --> 00:00:31.399 rates uh you know if you have followed 00:00:29.719 --> 00:00:35.238 the news there's a lot of debate on 00:00:31.399 --> 00:00:37.280 these days on on on where will the 00:00:35.238 --> 00:00:40.679 interest rate in the US end at the end 00:00:37.280 --> 00:00:43.679 of this Titan tiing tightening 00:00:40.679 --> 00:00:43.679 cycle 00:00:46.920 --> 00:00:52.640 uh and um so I'll show you there has 00:00:50.799 --> 00:00:54.558 been a very aggressive monetary policy 00:00:52.640 --> 00:00:57.600 trying to fight the inflationary episode 00:00:54.558 --> 00:01:00.039 we're going through uh and that's done 00:00:57.600 --> 00:01:03.280 through interest rates and and the 00:01:00.039 --> 00:01:05.239 question that I want to address today is 00:01:03.280 --> 00:01:07.118 H well how is it that the interest rate 00:01:05.239 --> 00:01:11.000 is determined so when a central bank 00:01:07.118 --> 00:01:13.719 decides to hike interest rates how do 00:01:11.000 --> 00:01:15.438 they do that okay and obviously this is 00:01:13.719 --> 00:01:17.679 about financial markets interest rate 00:01:15.438 --> 00:01:19.158 are set in financial markets and 00:01:17.680 --> 00:01:21.799 financial markets are very very 00:01:19.159 --> 00:01:23.400 complicated so we're going to keep it 00:01:21.799 --> 00:01:25.079 very very simple we're want to make 00:01:23.400 --> 00:01:26.400 introduce more complexity later on in 00:01:25.078 --> 00:01:28.599 the course but still we're going to keep 00:01:26.400 --> 00:01:31.320 it pretty simple because our main 00:01:28.599 --> 00:01:35.839 objective in studying Financial Market 00:01:31.319 --> 00:01:38.199 is really a a to to re to achieve some 00:01:35.840 --> 00:01:39.799 sort of understanding of how the 00:01:38.200 --> 00:01:43.159 interest rate policy that the Central 00:01:39.799 --> 00:01:46.410 Bank H controls is is 00:01:43.159 --> 00:01:48.439 determined so before 00:01:46.409 --> 00:01:51.560 [Music] 00:01:48.438 --> 00:01:54.679 I I get into specifics so let's let's 00:01:51.560 --> 00:01:56.799 see some trivia here who knows who that 00:01:54.680 --> 00:02:00.439 person is 00:01:56.799 --> 00:02:04.240 okay you 00:02:00.438 --> 00:02:04.239 Geron Powell exactly and who's Jeron 00:02:04.840 --> 00:02:11.159 Powell the chair of the Federal Reserve 00:02:08.199 --> 00:02:13.878 uh system in the US which is the Central 00:02:11.159 --> 00:02:17.120 Bank of the US okay so that's that was 00:02:13.878 --> 00:02:19.000 an easy one and and every you know if 00:02:17.120 --> 00:02:20.319 you are into financial markets everyone 00:02:19.000 --> 00:02:22.560 is worried about what this guy is 00:02:20.318 --> 00:02:24.639 thinking and his friends are thinking at 00:02:22.560 --> 00:02:26.239 this moment because they determine the 00:02:24.639 --> 00:02:28.518 interest rate how do they do that well 00:02:26.239 --> 00:02:32.640 that's what we're going to talk about 00:02:28.519 --> 00:02:32.640 later on a little speaker who is 00:02:34.239 --> 00:02:38.080 this no no that's that's 00:02:38.318 --> 00:02:45.199 cheating katsu WEA he is the next ER 00:02:43.318 --> 00:02:49.039 president of the bank of Japan the 00:02:45.199 --> 00:02:50.479 Central Bank of Japan and an interesting 00:02:49.039 --> 00:02:52.799 there are many interesting things of him 00:02:50.479 --> 00:02:54.840 but about him but he's a he's a graduate 00:02:52.800 --> 00:02:58.680 from our program the PHD 00:02:54.840 --> 00:03:00.878 program which actually is an incredibly 00:02:58.680 --> 00:03:04.280 successful program at producing major 00:03:00.878 --> 00:03:06.000 Central Bankers Ben Bernan is our Alum 00:03:04.280 --> 00:03:09.318 Alum that he was 00:03:06.000 --> 00:03:11.239 the the chairman of the Central Bank the 00:03:09.318 --> 00:03:14.919 chair of the Central Bank of the FED 00:03:11.239 --> 00:03:17.360 during the financial crisis Mario dragi 00:03:14.919 --> 00:03:21.439 is a one of our graduates Mario dragi 00:03:17.360 --> 00:03:24.000 was the the most successful ER Central 00:03:21.439 --> 00:03:27.719 Banker in Europe he was the president of 00:03:24.000 --> 00:03:29.120 the ECB European Central Bank for many 00:03:27.719 --> 00:03:32.080 years and in particular during the 00:03:29.120 --> 00:03:33.438 Global Financial crisis and the European 00:03:32.080 --> 00:03:34.799 crisis which followed the global 00:03:33.438 --> 00:03:38.519 financial 00:03:34.799 --> 00:03:41.319 crisis uh I mean but you name it Stan 00:03:38.519 --> 00:03:43.959 Fisher in the past of the Bank of Israel 00:03:41.318 --> 00:03:47.639 and nowadays feel low of the the chair 00:03:43.959 --> 00:03:50.400 of the Reserve Bank of Australia in 00:03:47.639 --> 00:03:52.199 Chile we have had two or three er 00:03:50.400 --> 00:03:53.840 presents and so on so if you if this is 00:03:52.199 --> 00:03:56.078 your career this is a good program you 00:03:53.840 --> 00:03:58.759 should join our program you may end up 00:03:56.079 --> 00:04:00.599 in a in a good place but that's the the 00:03:58.759 --> 00:04:02.318 next one for Japan 00:04:00.598 --> 00:04:04.238 and and Japan is a very interesting 00:04:02.318 --> 00:04:06.839 place from the point of view of monetary 00:04:04.239 --> 00:04:08.840 policy precisely because they they 00:04:06.840 --> 00:04:10.438 haven't had much space to do 00:04:08.840 --> 00:04:12.319 conventional monetary policy so they 00:04:10.438 --> 00:04:14.280 have had to do lots of unconventional 00:04:12.318 --> 00:04:17.199 things from the point of view of what a 00:04:14.280 --> 00:04:18.798 central bank typically does but today 00:04:17.199 --> 00:04:20.160 we're going to study conventional things 00:04:18.798 --> 00:04:22.519 and we'll talk a little bit more about 00:04:20.160 --> 00:04:25.560 unconventional things later in the 00:04:22.519 --> 00:04:28.399 course now some institutional knowledge 00:04:25.560 --> 00:04:29.959 this is the the again in the US the 00:04:28.399 --> 00:04:31.959 Central Bank of the US is called called 00:04:29.959 --> 00:04:36.839 the Federal Reserve System and it's a 00:04:31.959 --> 00:04:39.159 system really H it's a he has a um in um 00:04:36.839 --> 00:04:40.719 the Board of Governors which sits in 00:04:39.160 --> 00:04:43.400 Washington 00:04:40.720 --> 00:04:46.680 DC um and and there are seven Governors 00:04:43.399 --> 00:04:48.799 and the governors are are are nominated 00:04:46.680 --> 00:04:51.800 by the president and and then confirmed 00:04:48.800 --> 00:04:56.879 by by the Senate and the president of 00:04:51.800 --> 00:04:59.840 that board is is H is so the president 00:04:56.879 --> 00:05:03.439 of the FED of the FED will be one of 00:04:59.839 --> 00:05:05.478 those members okay now on in addition to 00:05:03.439 --> 00:05:08.360 that the the US has a Federal Reserve 00:05:05.478 --> 00:05:11.719 Bank system there are seven there are 12 00:05:08.360 --> 00:05:13.600 Regional Banks uh there's one in Boston 00:05:11.720 --> 00:05:15.800 in fact if you look at the skyline near 00:05:13.600 --> 00:05:19.479 the Waterfront there's a building built 00:05:15.800 --> 00:05:23.720 out of recycled aluminum well that's the 00:05:19.478 --> 00:05:27.120 Reserve Bank of Boston and uh and uh and 00:05:23.720 --> 00:05:30.400 of those 12 Regional Banks they 00:05:27.120 --> 00:05:32.120 rotate so so policy the interested is 00:05:30.399 --> 00:05:35.758 set into in a committee which is called 00:05:32.120 --> 00:05:38.720 the fomc Federal Open Market Committee 00:05:35.759 --> 00:05:41.360 um and and the member of that the voting 00:05:38.720 --> 00:05:45.199 members of that committee are the the 00:05:41.360 --> 00:05:48.720 seven Governors plus h four out of the 00:05:45.199 --> 00:05:50.639 12 and they rotate most of them rotate 00:05:48.720 --> 00:05:53.759 the the only one I think does not rotate 00:05:50.639 --> 00:05:56.918 is the is the is the president of the of 00:05:53.759 --> 00:05:58.840 the New York fed because they're so 00:05:56.918 --> 00:06:00.359 important because that's a financial 00:05:58.839 --> 00:06:04.638 heart of the US 00:06:00.360 --> 00:06:06.720 that you certainly want that H ER 00:06:04.639 --> 00:06:09.240 president to be involved in in interest 00:06:06.720 --> 00:06:11.120 rate decisions and it's really the FED 00:06:09.240 --> 00:06:12.960 that is in charge of communication with 00:06:11.120 --> 00:06:16.038 financial Market which is a huge thing 00:06:12.959 --> 00:06:18.879 for the FED okay they are in New York 00:06:16.038 --> 00:06:20.959 and they're crucial for that okay so 00:06:18.879 --> 00:06:23.199 that's that's that's those are the 00:06:20.959 --> 00:06:26.799 people that and in most places around 00:06:23.199 --> 00:06:28.720 the world you're going to have at least 00:06:26.800 --> 00:06:31.759 something equivalent to the the seven 00:06:28.720 --> 00:06:33.960 governors out there okay most places 00:06:31.759 --> 00:06:35.759 obviously the ECB is different because 00:06:33.959 --> 00:06:38.758 it's multiple countries so each country 00:06:35.759 --> 00:06:41.639 sends one member 00:06:38.759 --> 00:06:44.960 no but but but 00:06:41.639 --> 00:06:48.639 otherwise um it tends to be like like 00:06:44.959 --> 00:06:51.519 the US without the the the regional 00:06:48.639 --> 00:06:53.079 Banks so why do we care about monetary 00:06:51.519 --> 00:06:54.879 policy well because I think it's one of 00:06:53.079 --> 00:06:56.359 the main policy tools you have in the 00:06:54.879 --> 00:06:58.918 short run remember in this part of the 00:06:56.360 --> 00:07:01.439 course we're trying to understand output 00:06:58.918 --> 00:07:03.399 in the short ter and one of the main 00:07:01.439 --> 00:07:06.719 policy levels I mean how can you affect 00:07:03.399 --> 00:07:08.598 output is monetary policy which one is 00:07:06.720 --> 00:07:12.160 the other 00:07:08.598 --> 00:07:14.399 one there are two major ones fiscal 00:07:12.160 --> 00:07:16.000 policy exactly and fiscal policy we did 00:07:14.399 --> 00:07:18.198 look at in the previous lecture remember 00:07:16.000 --> 00:07:20.959 we said an expansionary fiscal policies 00:07:18.199 --> 00:07:22.680 an increase in G or a decline in t would 00:07:20.959 --> 00:07:25.439 lead to an expansion in a great demand 00:07:22.680 --> 00:07:27.598 equilibrium output would go out up okay 00:07:25.439 --> 00:07:30.240 so fiscal policy is something you always 00:07:27.598 --> 00:07:32.560 use in in in deep recessions 00:07:30.240 --> 00:07:35.038 uh but monetary policy is much more 00:07:32.560 --> 00:07:36.918 Nimble is I mean it's a it's a bunch of 00:07:35.038 --> 00:07:38.800 people that need to meet and just change 00:07:36.918 --> 00:07:40.198 the interest rate anything that is 00:07:38.800 --> 00:07:42.759 fiscal there are some automatic 00:07:40.199 --> 00:07:44.400 stabilizers by the way so automatically 00:07:42.759 --> 00:07:46.759 fiscal policy becomes more expansionary 00:07:44.399 --> 00:07:48.598 during recessions and stuff like that 00:07:46.759 --> 00:07:50.840 but any deviation from the typical 00:07:48.598 --> 00:07:53.478 automatic stabilizers require Congress 00:07:50.839 --> 00:07:55.758 to approve things it's a long process 00:07:53.478 --> 00:07:59.598 and so it's not something that can react 00:07:55.759 --> 00:08:01.479 as quickly as monetary policy can okay 00:07:59.598 --> 00:08:03.000 um so that's what we're going to look 00:08:01.478 --> 00:08:04.758 that's that's that's that's the reason 00:08:03.000 --> 00:08:07.399 why monetary policy is important for us 00:08:04.759 --> 00:08:10.759 at this point then there are medium and 00:08:07.399 --> 00:08:12.638 long run issues fiscal policies still 00:08:10.759 --> 00:08:14.960 affects equilibrium output in the medium 00:08:12.639 --> 00:08:17.400 and long run monetary policies much less 00:08:14.959 --> 00:08:19.519 effective at that it's very difficult to 00:08:17.399 --> 00:08:21.120 to change sort of equilibrium growth or 00:08:19.519 --> 00:08:23.519 things like that with monetary policy 00:08:21.120 --> 00:08:25.800 it's going to be pretty minor most of 00:08:23.519 --> 00:08:27.359 the impact of monetary policy in the 00:08:25.800 --> 00:08:29.680 minum and long run is really on the 00:08:27.360 --> 00:08:31.439 price level and inflation more than on 00:08:29.680 --> 00:08:33.080 real activity okay but in the short run 00:08:31.439 --> 00:08:35.038 it's very powerful for reasons that 00:08:33.080 --> 00:08:37.278 we're going to discuss in this and the 00:08:35.038 --> 00:08:37.278 next 00:08:40.399 --> 00:08:46.639 lecture okay so as I said well monetary 00:08:44.120 --> 00:08:48.039 policy acts through financial markets I 00:08:46.639 --> 00:08:50.278 I think it's a very 00:08:48.039 --> 00:08:52.399 interesting part of my research agenda 00:08:50.278 --> 00:08:54.480 is about that is I think is the central 00:08:52.399 --> 00:08:57.440 bank is a very strange institution 00:08:54.480 --> 00:09:00.240 because most of its mandate are in terms 00:08:57.440 --> 00:09:02.600 of what happens in the Goods Market says 00:09:00.240 --> 00:09:04.159 you know you don't try not to get into 00:09:02.600 --> 00:09:06.800 recession try to get us out of a 00:09:04.159 --> 00:09:08.958 recession and so on but unlike fiscal 00:09:06.799 --> 00:09:11.159 policy which has tools that are directly 00:09:08.958 --> 00:09:12.879 aim at the Goods Market remember it's a 00:09:11.159 --> 00:09:14.240 it's a purchases by the government of 00:09:12.879 --> 00:09:17.078 goods so if there isn't sufficient 00:09:14.240 --> 00:09:18.639 demand for goods the fiscal policy the 00:09:17.078 --> 00:09:21.719 fiscal Authority can go out there and 00:09:18.639 --> 00:09:23.958 buy Goods that creates more demand the 00:09:21.720 --> 00:09:26.519 the central bank is given the same 00:09:23.958 --> 00:09:27.679 mandate aside from Price stability and 00:09:26.519 --> 00:09:29.399 things like that we're want to worry 00:09:27.679 --> 00:09:31.479 about later but it doesn't have any 00:09:29.399 --> 00:09:33.000 tools the the the central bank if 00:09:31.480 --> 00:09:34.399 there's insufficient demand the Central 00:09:33.000 --> 00:09:36.600 Bank cannot go out there and buy 00:09:34.399 --> 00:09:38.399 hamburgers right that's fiscal policy 00:09:36.600 --> 00:09:41.360 can do that and expand the demand for 00:09:38.399 --> 00:09:45.000 hamburgers but not monetary policy what 00:09:41.360 --> 00:09:47.159 monetary policy can do is by bonds by 00:09:45.000 --> 00:09:49.839 instruments in the financial markets and 00:09:47.159 --> 00:09:53.600 through that affects real activity so 00:09:49.839 --> 00:09:55.320 the is it's the fastest policy tool but 00:09:53.600 --> 00:09:57.200 it's the most indirect in a sense 00:09:55.320 --> 00:10:00.360 because it it it has to go through 00:09:57.200 --> 00:10:02.480 financial market and and and and that CH 00:10:00.360 --> 00:10:05.000 those channels can be very complex but 00:10:02.480 --> 00:10:06.879 obviously we're not in the business of 00:10:05.000 --> 00:10:09.120 complicating things in this course so 00:10:06.879 --> 00:10:11.600 we're going to make it very very simple 00:10:09.120 --> 00:10:14.839 we're going to assume that financial 00:10:11.600 --> 00:10:16.519 markets only have two instruments 00:10:14.839 --> 00:10:17.959 obviously the huge simplification there 00:10:16.519 --> 00:10:20.399 are millions of financial instruments 00:10:17.958 --> 00:10:22.239 out there but we're going to isolate two 00:10:20.399 --> 00:10:23.919 instruments because this happens to be 00:10:22.240 --> 00:10:27.360 the instrument 00:10:23.919 --> 00:10:30.360 where that that that where the central 00:10:27.360 --> 00:10:33.278 banks typically participate 00:10:30.360 --> 00:10:36.039 they affect all asset prices around but 00:10:33.278 --> 00:10:37.519 the direct interventions typically 00:10:36.039 --> 00:10:41.159 recently has been a little different but 00:10:37.519 --> 00:10:43.039 typically it's only in this kind of 00:10:41.159 --> 00:10:44.600 instruments and so we're going to focus 00:10:43.039 --> 00:10:46.199 all of our analysis on on those two 00:10:44.600 --> 00:10:49.040 instruments for now later on we're going 00:10:46.200 --> 00:10:52.040 to talk about equity and stuff like that 00:10:49.039 --> 00:10:55.240 but but just to isolate the the the how 00:10:52.039 --> 00:10:57.199 monetary policy works is sufficient to 00:10:55.240 --> 00:10:58.440 just focus on two financial instruments 00:10:57.200 --> 00:11:02.000 so we're going to assume that people 00:10:58.440 --> 00:11:04.959 have their wealth in only two forms in 00:11:02.000 --> 00:11:06.000 two Financial assets one we're going to 00:11:04.958 --> 00:11:08.000 call it 00:11:06.000 --> 00:11:11.320 money and the other one we want to call 00:11:08.000 --> 00:11:13.919 it bonds okay 00:11:11.320 --> 00:11:15.480 money the characteristic of money what 00:11:13.919 --> 00:11:18.599 we call money there are many definitions 00:11:15.480 --> 00:11:21.440 of money M1 M2 M3 M4 but let's keep it 00:11:18.600 --> 00:11:23.079 very simple money essentially means 00:11:21.440 --> 00:11:24.079 something that you can use very easily 00:11:23.078 --> 00:11:29.399 for 00:11:24.078 --> 00:11:32.359 transactions okay so for example the the 00:11:29.399 --> 00:11:34.919 most important example of money not the 00:11:32.360 --> 00:11:38.240 largest but the most important one is 00:11:34.919 --> 00:11:43.000 Cash currency okay you can buy anything 00:11:38.240 --> 00:11:45.919 with cash there no problem whatsoever 00:11:43.000 --> 00:11:48.480 now the the the a characteristic that 00:11:45.919 --> 00:11:49.838 money typically does not have is that it 00:11:48.480 --> 00:11:53.200 doesn't give you any 00:11:49.839 --> 00:11:55.160 return you don't invest in cash you know 00:11:53.200 --> 00:11:57.560 you have cash because you need to do 00:11:55.159 --> 00:12:00.879 transactions but it's not the way you 00:11:57.559 --> 00:12:02.759 get a return and so money that's what 00:12:00.879 --> 00:12:04.958 it's going to mean for us is something 00:12:02.759 --> 00:12:07.240 that is used in transactions but it pays 00:12:04.958 --> 00:12:10.599 no interest rate no interest there no 00:12:07.240 --> 00:12:12.959 interest on that a bond is going to be 00:12:10.600 --> 00:12:14.720 the polar opposite it's going to be 00:12:12.958 --> 00:12:18.359 something that pays a positive interest 00:12:14.720 --> 00:12:19.759 rate so if you buy a bone for 100 for 95 00:12:18.360 --> 00:12:21.919 you're going to get a 100 a year from 00:12:19.759 --> 00:12:23.879 now say so you get something out of that 00:12:21.919 --> 00:12:26.039 bone but it's not very useful for 00:12:23.879 --> 00:12:28.879 transactions I mean you cannot go and 00:12:26.039 --> 00:12:30.799 buy your lunch with a bond you get the 00:12:28.879 --> 00:12:32.559 piece of B for that and and and many 00:12:30.799 --> 00:12:34.919 things cannot be even even within 00:12:32.559 --> 00:12:36.679 financial markets you cannot buy asset 00:12:34.919 --> 00:12:39.198 with asset you have to go through some 00:12:36.679 --> 00:12:41.879 process in which you come sell something 00:12:39.198 --> 00:12:43.838 get cash and and with cash you pay for 00:12:41.879 --> 00:12:46.879 the other stuff not necessarily cash it 00:12:43.839 --> 00:12:48.800 could be other forms of money but but 00:12:46.879 --> 00:12:50.679 but typically Financial instrument need 00:12:48.799 --> 00:12:53.559 to be sold before you can buy something 00:12:50.679 --> 00:12:55.679 else you don't swap them it's not a part 00:12:53.559 --> 00:12:59.239 them okay but this is what it means for 00:12:55.679 --> 00:13:01.239 us so this whenever you see something 00:12:59.240 --> 00:13:04.240 like this is always interesting for an 00:13:01.240 --> 00:13:04.240 economist 00:13:06.440 --> 00:13:14.160 why and any economies micro economies or 00:13:10.360 --> 00:13:16.720 whatever what what have I done 00:13:14.159 --> 00:13:18.078 there that makes economics is about 00:13:16.720 --> 00:13:22.000 decisions and then it's about 00:13:18.078 --> 00:13:22.000 equilibrium okay it's decisions and 00:13:22.559 --> 00:13:27.879 equilibrium there's a decision to be 00:13:24.559 --> 00:13:29.399 made here there's a tradeoff okay I I 00:13:27.879 --> 00:13:31.439 you know if I need to do lots of 00:13:29.399 --> 00:13:35.000 transactions I better sort of bias my 00:13:31.440 --> 00:13:35.959 portfolio towards cash towards money if 00:13:35.000 --> 00:13:38.000 if I don't need to do lots of 00:13:35.958 --> 00:13:39.919 transaction then I and the interest rate 00:13:38.000 --> 00:13:42.078 is very high particularly then I this is 00:13:39.919 --> 00:13:44.360 an issue today today interest rates are 00:13:42.078 --> 00:13:47.198 very high nobody care about bonds or 00:13:44.360 --> 00:13:49.000 anything you know two years ago when 00:13:47.198 --> 00:13:51.120 interest rate was Zero but today 00:13:49.000 --> 00:13:52.480 interest rate is 5% so it's an issue 00:13:51.120 --> 00:13:54.039 you're not going to if you want to keep 00:13:52.480 --> 00:13:56.800 it in cash you're going to give up a lot 00:13:54.039 --> 00:13:58.278 of return okay so it's a decision to be 00:13:56.799 --> 00:14:00.838 made there a portfolio decision and 00:13:58.278 --> 00:14:05.159 that's always interesting for 00:14:00.839 --> 00:14:07.839 economies so let's talk about uh that 00:14:05.159 --> 00:14:09.360 decision and we're going to talk you can 00:14:07.839 --> 00:14:11.120 describe this decision either from the 00:14:09.360 --> 00:14:12.320 side of bonds or from the side of money 00:14:11.120 --> 00:14:14.240 we're going to describe from the side of 00:14:12.320 --> 00:14:16.959 money because there's a total amount of 00:14:14.240 --> 00:14:20.159 wealth and you have to decide what to 00:14:16.958 --> 00:14:21.599 allocate it to so you know it suffices 00:14:20.159 --> 00:14:24.480 if I tell you there a total amount of 00:14:21.600 --> 00:14:26.120 wealth and if I tell you how to how much 00:14:24.480 --> 00:14:27.240 you allocate to money then I'm telling 00:14:26.120 --> 00:14:29.440 you implicitly how much you are 00:14:27.240 --> 00:14:31.680 allocating to bonds it's a compliment to 00:14:29.440 --> 00:14:33.639 that okay so I can do analysis either 00:14:31.679 --> 00:14:36.359 way but I'm going to do it through money 00:14:33.639 --> 00:14:38.399 which is the way is normally done so 00:14:36.360 --> 00:14:39.720 money demand if I plot it in the space 00:14:38.399 --> 00:14:43.399 of 00:14:39.720 --> 00:14:45.480 M money and the interest rate is a 00:14:43.399 --> 00:14:49.759 downward sloping 00:14:45.480 --> 00:14:49.759 curve why is it a downward sloping 00:14:51.198 --> 00:14:56.240 curve the interest rate is higher it 00:14:54.120 --> 00:14:59.078 pays off more to have B your utility 00:14:56.240 --> 00:15:01.399 should exactly your decision if the 00:14:59.078 --> 00:15:03.559 interest rate is very high is to go more 00:15:01.399 --> 00:15:04.958 towards bone the interest is very low I 00:15:03.559 --> 00:15:06.198 don't care too much about bones I'd 00:15:04.958 --> 00:15:09.439 rather keep the thing that helps me 00:15:06.198 --> 00:15:12.519 transact which is money okay and it's 00:15:09.440 --> 00:15:14.839 interesting because for most of your 00:15:12.519 --> 00:15:16.078 adult life you have Liv in a world in 00:15:14.839 --> 00:15:18.680 which that not was not a very 00:15:16.078 --> 00:15:21.078 interesting decision actually no because 00:15:18.679 --> 00:15:22.679 interest were very close to zero now 00:15:21.078 --> 00:15:25.399 you're living in a different environment 00:15:22.679 --> 00:15:28.359 interest Are For the First Time sort of 00:15:25.399 --> 00:15:30.720 high for you there may a bigger decision 00:15:28.360 --> 00:15:34.159 between invest in equity say and cash 00:15:30.720 --> 00:15:36.120 but bonds and and and and these are safe 00:15:34.159 --> 00:15:37.719 bonds by the way your treasures and 00:15:36.120 --> 00:15:40.198 things like that and money is not 00:15:37.720 --> 00:15:43.600 something you have to worry 00:15:40.198 --> 00:15:45.198 about okay good what I'm saying is 00:15:43.600 --> 00:15:47.399 interest is where around here so you 00:15:45.198 --> 00:15:50.399 we're all in cash one way or the other 00:15:47.399 --> 00:15:52.198 and now interest are a lot High the 00:15:50.399 --> 00:15:53.759 other thing that so that's a movement 00:15:52.198 --> 00:15:56.799 along the curve no I'm plotting 00:15:53.759 --> 00:15:58.680 something in the space of interest rate 00:15:56.799 --> 00:15:59.479 money and interest rate then when I tell 00:15:58.679 --> 00:16:01.479 you 00:15:59.480 --> 00:16:04.720 what happens when the inter Rises I'm 00:16:01.480 --> 00:16:07.480 asking you for a a a movement along the 00:16:04.720 --> 00:16:11.240 curve okay I see so if I raise interest 00:16:07.480 --> 00:16:12.879 rate I move along the curve up so the 00:16:11.240 --> 00:16:14.600 second thing that we have there is 00:16:12.879 --> 00:16:16.078 argument we have is something that shift 00:16:14.600 --> 00:16:18.319 the curve because it's not part of my 00:16:16.078 --> 00:16:20.599 Axis so so it will shift the curve it's 00:16:18.318 --> 00:16:24.240 a parameter for each of these curves and 00:16:20.600 --> 00:16:26.720 that's nominal income so in particular 00:16:24.240 --> 00:16:29.159 if nominal income goes 00:16:26.720 --> 00:16:31.278 up I'm showing you there that money 00:16:29.159 --> 00:16:32.399 demand goes out meaning for any given 00:16:31.278 --> 00:16:33.838 level of interest rate you're going to 00:16:32.399 --> 00:16:37.120 demand more 00:16:33.839 --> 00:16:38.639 money why do you think that's the case 00:16:37.120 --> 00:16:41.198 and again I'm looking here at the 00:16:38.639 --> 00:16:43.759 aggregate but but it applies to an 00:16:41.198 --> 00:16:43.758 individual as 00:16:44.639 --> 00:16:51.680 well so for the same level of wealth now 00:16:49.600 --> 00:16:54.319 nominal GDP is 00:16:51.679 --> 00:16:58.439 higher remember that nominal GDP is the 00:16:54.318 --> 00:17:00.838 same as nominal expenditure here okay so 00:16:58.440 --> 00:17:02.120 if GDP is higher then that means there's 00:17:00.839 --> 00:17:03.400 going to be more transactions because 00:17:02.120 --> 00:17:07.160 there's going to be more 00:17:03.399 --> 00:17:09.759 expenditure okay and therefore you need 00:17:07.160 --> 00:17:12.480 more of the thing that is use useful for 00:17:09.759 --> 00:17:14.640 transactions okay M demand goes up the 00:17:12.480 --> 00:17:17.959 second point to highlight is that you 00:17:14.640 --> 00:17:20.520 know while in most places I we use why 00:17:17.959 --> 00:17:22.240 here I'm using dollar y nominal y why do 00:17:20.519 --> 00:17:24.558 you think that's that why why don't I 00:17:22.240 --> 00:17:27.959 just put there real GDP rather than 00:17:24.558 --> 00:17:27.959 nominal GDP 00:17:30.240 --> 00:17:32.679 is the 00:17:34.679 --> 00:17:40.679 typo let's go in 00:17:37.319 --> 00:17:43.678 steps suppose that prices are totally 00:17:40.679 --> 00:17:46.440 fixed and real GDP goes 00:17:43.679 --> 00:17:47.720 up that means that this economy needs 00:17:46.440 --> 00:17:51.038 more transactions because it's going to 00:17:47.720 --> 00:17:53.640 be more expenditure there okay so that 00:17:51.038 --> 00:17:56.158 that explains that yeah when real output 00:17:53.640 --> 00:17:57.880 goes up then money demand goes up when I 00:17:56.159 --> 00:18:00.120 say money demand goes up I said for any 00:17:57.880 --> 00:18:04.520 given interest rate we have more money 00:18:00.119 --> 00:18:08.239 demand okay now fix real output and I 00:18:04.519 --> 00:18:08.240 tell you suppose that the price of goods 00:18:08.720 --> 00:18:14.839 doubles do you think you need more money 00:18:10.880 --> 00:18:17.120 to transact of course because it's the 00:18:14.839 --> 00:18:19.918 same it's equivalent now money is 00:18:17.119 --> 00:18:21.599 dollars I have $10 and now prices are 00:18:19.919 --> 00:18:24.720 twice what they used to be well I'm 00:18:21.599 --> 00:18:26.399 going to need more dollars to transact 00:18:24.720 --> 00:18:30.400 okay so that's a reason we have nominal 00:18:26.400 --> 00:18:32.159 GDP here rather than real GDP 00:18:30.400 --> 00:18:35.640 okay 00:18:32.159 --> 00:18:36.600 good so let's now determine the interest 00:18:35.640 --> 00:18:39.080 rate and I'm going to do it in the 00:18:36.599 --> 00:18:42.359 simplest possible model first and and by 00:18:39.079 --> 00:18:44.639 simplest I mean here in particular no 00:18:42.359 --> 00:18:49.038 banks no intermediaries okay so there's 00:18:44.640 --> 00:18:52.120 only Central Bank and and and and and 00:18:49.038 --> 00:18:54.679 people okay so 00:18:52.119 --> 00:18:57.119 so suppose that the central banks 00:18:54.679 --> 00:18:59.080 decides that wants to this is the way 00:18:57.119 --> 00:19:01.319 monetary policy used to be conducted 00:18:59.079 --> 00:19:04.879 suppose is the size that it wants to 00:19:01.319 --> 00:19:06.439 offer M dollars to the economy and the 00:19:04.880 --> 00:19:09.200 central bank is the one that produces 00:19:06.440 --> 00:19:13.679 the at this moment which I have no 00:19:09.200 --> 00:19:16.279 intermediaries a ER money is really 00:19:13.679 --> 00:19:19.880 currency okay the only one that can 00:19:16.279 --> 00:19:22.720 produce currency forget Bitcoin only one 00:19:19.880 --> 00:19:26.039 that can produce currency is the Central 00:19:22.720 --> 00:19:28.839 Bank okay I mean dollars you can no one 00:19:26.038 --> 00:19:30.319 else can produce dollars 00:19:28.839 --> 00:19:32.038 watch out when we talk about Banks later 00:19:30.319 --> 00:19:34.200 on in this economy I'm describing there 00:19:32.038 --> 00:19:36.640 are no banks the only one that can 00:19:34.200 --> 00:19:38.960 produce Dollars currency is the Central 00:19:36.640 --> 00:19:42.000 Bank any other one that produces dollars 00:19:38.960 --> 00:19:44.240 that's illegal okay so it's a central 00:19:42.000 --> 00:19:45.558 bank so the central bank can decide how 00:19:44.240 --> 00:19:48.720 much money to 00:19:45.558 --> 00:19:52.158 supply and suppose it decides to supply 00:19:48.720 --> 00:19:55.360 M that's it it's a 00:19:52.159 --> 00:19:57.600 decision well what is a now for the 00:19:55.359 --> 00:19:59.359 first time I can I can answer the 00:19:57.599 --> 00:20:02.319 question is well what the interest rate 00:19:59.359 --> 00:20:04.599 in this environment why do I know that 00:20:02.319 --> 00:20:07.200 because I have a money supply I have a 00:20:04.599 --> 00:20:09.319 money demand the intersection at this 00:20:07.200 --> 00:20:10.840 level of money supply the equilibrium 00:20:09.319 --> 00:20:12.240 interest rate that is interest is 00:20:10.839 --> 00:20:15.720 consistent with money demand equal to 00:20:12.240 --> 00:20:18.720 money supply is that 00:20:15.720 --> 00:20:18.720 one 00:20:19.640 --> 00:20:26.440 okay is it clear so I have my money 00:20:23.159 --> 00:20:27.880 demand and I'm saying the Central Bank 00:20:26.440 --> 00:20:30.080 suppos the Central Bank De size to 00:20:27.880 --> 00:20:32.000 supply m well in equilibrium that will 00:20:30.079 --> 00:20:34.319 be the interest 00:20:32.000 --> 00:20:36.240 rate okay that's the way the interest 00:20:34.319 --> 00:20:39.240 rate is 00:20:36.240 --> 00:20:39.240 determined 00:20:40.240 --> 00:20:45.919 now suppose that the Central Bank 00:20:42.839 --> 00:20:48.480 increases remember the the goal of this 00:20:45.919 --> 00:20:50.480 lecture is that we get to understand how 00:20:48.480 --> 00:20:52.480 is that interest rate is deter is 00:20:50.480 --> 00:20:54.400 determined how is that the fed the 00:20:52.480 --> 00:20:57.599 Central Bank determines the interest 00:20:54.400 --> 00:20:59.519 rate here we said look the Central Bank 00:20:57.599 --> 00:21:00.959 decide on certain am amount of money and 00:20:59.519 --> 00:21:02.240 then the market determines what the 00:21:00.960 --> 00:21:04.880 interest rate 00:21:02.240 --> 00:21:07.359 is and this is the way monetary policy 00:21:04.880 --> 00:21:09.200 used to be conducted the central banks 00:21:07.359 --> 00:21:10.639 would typically decide the amount of 00:21:09.200 --> 00:21:13.240 money in the system it was called 00:21:10.640 --> 00:21:14.799 monetary Aggregates the amount of money 00:21:13.240 --> 00:21:16.359 in the system and then the market would 00:21:14.798 --> 00:21:19.519 determine the interest 00:21:16.359 --> 00:21:21.879 rate it turned out that that was a 00:21:19.519 --> 00:21:24.200 nightmare and so now that's that's not 00:21:21.880 --> 00:21:26.919 what central banks do but and it was a 00:21:24.200 --> 00:21:29.240 night mayor because this money demand 00:21:26.919 --> 00:21:31.200 that looks so peaceful here in practice 00:21:29.240 --> 00:21:34.159 is moving around all the time for a 00:21:31.200 --> 00:21:36.278 variety of reason you know even holidays 00:21:34.159 --> 00:21:38.799 affect the money demand and all that so 00:21:36.278 --> 00:21:40.480 so if you fix the monetary Aggregates 00:21:38.798 --> 00:21:43.599 and many the man is moving all over the 00:21:40.480 --> 00:21:43.599 place what what 00:21:44.159 --> 00:21:48.360 happens suppose the Central Bank says 00:21:46.519 --> 00:21:50.480 I'm going to offer this amount of M 00:21:48.359 --> 00:21:51.719 that's it and now I tell you money the 00:21:50.480 --> 00:21:53.000 money is moving all over the place 00:21:51.720 --> 00:21:55.960 they're weeks that they have you know 00:21:53.000 --> 00:21:58.000 three days of of weekend that have you 00:21:55.960 --> 00:22:00.798 know vacations in between or there's a 00:21:58.000 --> 00:22:06.000 Super Bowl lots of people decide to buy 00:22:00.798 --> 00:22:06.000 tickets or whatever or beer so 00:22:06.159 --> 00:22:09.520 whatever well 00:22:10.558 --> 00:22:16.839 no because when you say shortage I mean 00:22:14.000 --> 00:22:18.240 depends what you mean by shortage but so 00:22:16.839 --> 00:22:19.879 so you could be right with that part of 00:22:18.240 --> 00:22:22.640 the answer but but when you say exess 00:22:19.880 --> 00:22:23.880 theand then I have a problem because 00:22:22.640 --> 00:22:25.679 that's true only if the interest rate 00:22:23.880 --> 00:22:28.240 doesn't 00:22:25.679 --> 00:22:30.159 move but in a in a in a situation you 00:22:28.240 --> 00:22:33.919 could just the Central Bank fix M and 00:22:30.159 --> 00:22:35.600 let the market do its thing then the 00:22:33.919 --> 00:22:37.038 interest rate will not be fixed and 00:22:35.599 --> 00:22:39.558 that's exactly the problem that the 00:22:37.038 --> 00:22:41.558 interest rate becomes very very volatile 00:22:39.558 --> 00:22:44.158 if you if you do it only only through 00:22:41.558 --> 00:22:46.759 through monetary arates because this guy 00:22:44.159 --> 00:22:47.960 is moving all over the place and so 00:22:46.759 --> 00:22:49.919 imagine what happens if this demand 00:22:47.960 --> 00:22:52.720 shift up then in equilibrium it say goes 00:22:49.919 --> 00:22:55.320 up precisely to avoid your excess demand 00:22:52.720 --> 00:22:57.360 no because if this thing goes up I have 00:22:55.319 --> 00:22:58.839 an excess demand at that interest rate 00:22:57.359 --> 00:23:00.839 but what happen in equili is the 00:22:58.839 --> 00:23:04.158 interest rate will go up and so until 00:23:00.839 --> 00:23:07.678 the the excess demand 00:23:04.159 --> 00:23:10.120 disappears now in in central banks like 00:23:07.679 --> 00:23:12.038 the US Central Bank the FED they can 00:23:10.119 --> 00:23:13.519 control this stuff fairly well many 00:23:12.038 --> 00:23:16.278 other central banks don't have that if 00:23:13.519 --> 00:23:18.158 you look at the at the central at at the 00:23:16.278 --> 00:23:20.038 Bank of China for example they have lots 00:23:18.159 --> 00:23:21.760 of high frequency movements in interest 00:23:20.038 --> 00:23:25.200 rate because they not very good at doing 00:23:21.759 --> 00:23:27.400 this stuff it's it's not that easy to 00:23:25.200 --> 00:23:29.880 okay to to to control an interest rate 00:23:27.400 --> 00:23:32.240 for example to keep it we but the 00:23:29.880 --> 00:23:34.480 Central Bank used to do that that's what 00:23:32.240 --> 00:23:36.640 I'm saying used to do that I'm saying in 00:23:34.480 --> 00:23:38.440 practice this system wasn't very good 00:23:36.640 --> 00:23:40.799 because this in practice this the man is 00:23:38.440 --> 00:23:42.880 moving around for a lot of EOS syncratic 00:23:40.798 --> 00:23:44.400 reasons okay some of them are EOS 00:23:42.880 --> 00:23:46.559 syncratic some of them are very 00:23:44.400 --> 00:23:50.320 predictable there was a lot of panic 00:23:46.558 --> 00:23:52.240 around the shift of the year 2000 that 00:23:50.319 --> 00:23:54.599 the ATMs would stop working and stuff 00:23:52.240 --> 00:23:56.240 like that so it was a massive increase 00:23:54.599 --> 00:23:59.278 in money demand because people wanted to 00:23:56.240 --> 00:24:01.720 have cash just in case ATMs sto working 00:23:59.278 --> 00:24:03.319 okay and and so there are some are 00:24:01.720 --> 00:24:05.960 predictable and so but but you can get 00:24:03.319 --> 00:24:09.158 very large fluctuations so in practice 00:24:05.960 --> 00:24:10.640 what central banks do nowadays is really 00:24:09.159 --> 00:24:13.400 is they tell you what the interest rate 00:24:10.640 --> 00:24:15.320 is and then they offer whatever M the 00:24:13.400 --> 00:24:17.278 market needs for that interest rate 00:24:15.319 --> 00:24:19.200 that's the way modern monetary policy 00:24:17.278 --> 00:24:21.440 works okay I I'll tell you a little bit 00:24:19.200 --> 00:24:25.399 more about that so let's see what 00:24:21.440 --> 00:24:29.640 happens here if if if if 00:24:25.398 --> 00:24:30.798 uh if the suppose the the Fed 00:24:29.640 --> 00:24:32.799 for reasons that you'll understand 00:24:30.798 --> 00:24:34.359 better in the SEC in the next lecture 00:24:32.798 --> 00:24:37.278 suppose the FED decides that they want 00:24:34.359 --> 00:24:40.519 to have an expansionary monetary policy 00:24:37.278 --> 00:24:42.480 expansion in monetary policy means it's 00:24:40.519 --> 00:24:45.679 going to spand M it was offering certain 00:24:42.480 --> 00:24:49.360 amount of M and now it decides to offer 00:24:45.679 --> 00:24:51.519 more of the D so what happens in 00:24:49.359 --> 00:24:54.038 equilibrium well we start from an 00:24:51.519 --> 00:24:55.720 equilibrium here if the interest rate 00:24:54.038 --> 00:24:56.759 remains at that level now we have an 00:24:55.720 --> 00:24:59.399 excess 00:24:56.759 --> 00:25:01.679 supply of money 00:24:59.398 --> 00:25:04.959 okay and the only way to restore that 00:25:01.679 --> 00:25:07.919 equilibrium is by people demanding more 00:25:04.960 --> 00:25:10.558 money and how when will people demand 00:25:07.919 --> 00:25:11.200 more money well when the interest rate 00:25:10.558 --> 00:25:14.639 is 00:25:11.200 --> 00:25:17.000 lower okay so excess demand the interest 00:25:14.640 --> 00:25:18.520 start declining then demand for money 00:25:17.000 --> 00:25:21.720 starts catching up with a new higher 00:25:18.519 --> 00:25:23.038 supply of money okay and you end up with 00:25:21.720 --> 00:25:25.558 a lower interest 00:25:23.038 --> 00:25:27.759 rate okay so that's an expansion in 00:25:25.558 --> 00:25:30.480 monetary policy an increasing M that 00:25:27.759 --> 00:25:32.798 leads to a decline in the interest rate 00:25:30.480 --> 00:25:35.839 again mod than central banks don't tell 00:25:32.798 --> 00:25:37.519 you we're going to increase M by 20% 00:25:35.839 --> 00:25:41.359 what they tell you is we're going to cut 00:25:37.519 --> 00:25:43.599 interest rate by say 50 basis 00:25:41.359 --> 00:25:45.959 points when they tell you that they're 00:25:43.599 --> 00:25:47.398 going to C cut interest in by 50 point 00:25:45.960 --> 00:25:51.038 they're reading you this 00:25:47.398 --> 00:25:53.918 accxes but 00:25:51.038 --> 00:25:55.319 behind that operation there must have 00:25:53.919 --> 00:25:57.600 been an increase in money 00:25:55.319 --> 00:26:00.278 supply and then it comes all the fine 00:25:57.599 --> 00:26:02.000 tuning that that they have to do know so 00:26:00.278 --> 00:26:03.919 so the interestate remains there when 00:26:02.000 --> 00:26:05.919 the man is vibrating around that thing 00:26:03.919 --> 00:26:07.679 there but the when we say an 00:26:05.919 --> 00:26:11.120 expansionary monetary policy we really 00:26:07.679 --> 00:26:13.640 mean cutting interest rates how is the 00:26:11.119 --> 00:26:15.959 interest rates cut effectively by 00:26:13.640 --> 00:26:17.480 increasing the money supply but they 00:26:15.960 --> 00:26:20.880 don't tell you that they are doing that 00:26:17.480 --> 00:26:20.880 but that's what they're doing 00:26:22.519 --> 00:26:28.079 okay good so nowadays we're in the 00:26:26.200 --> 00:26:29.960 opposite process we're moving that way 00:26:28.079 --> 00:26:34.038 no 00:26:29.960 --> 00:26:35.759 up but you seen in every single meeting 00:26:34.038 --> 00:26:39.440 now for the last seven minutes or so we 00:26:35.759 --> 00:26:42.000 have seen a hike in interest ratees okay 00:26:39.440 --> 00:26:43.120 H well that's they don't tell you that 00:26:42.000 --> 00:26:45.919 but they're saying we're going to cut 00:26:43.119 --> 00:26:47.879 money supply and moving in that 00:26:45.919 --> 00:26:49.799 direction that 00:26:47.880 --> 00:26:52.640 direction because if they move in that 00:26:49.798 --> 00:26:54.879 direction then interest rate go 00:26:52.640 --> 00:26:58.880 up 00:26:54.880 --> 00:26:58.880 clear good 00:26:59.839 --> 00:27:06.558 what else shifts uh this is different 00:27:04.278 --> 00:27:08.720 kind of shift suppose that nominal 00:27:06.558 --> 00:27:10.558 income goes up and this is happening all 00:27:08.720 --> 00:27:12.200 the time nominal income is growing in 00:27:10.558 --> 00:27:14.200 most economies most of the time unless 00:27:12.200 --> 00:27:15.840 you're in a recession nominal income is 00:27:14.200 --> 00:27:17.080 growing it's growing for two reasons one 00:27:15.839 --> 00:27:19.599 because we have inflation and the other 00:27:17.079 --> 00:27:22.960 one is because real output is growing 00:27:19.599 --> 00:27:25.439 that means that that typically in an 00:27:22.960 --> 00:27:26.880 average year manyy demand is Shifting to 00:27:25.440 --> 00:27:28.759 the 00:27:26.880 --> 00:27:31.278 right okay 00:27:28.759 --> 00:27:33.119 so if money demand shift to the right 00:27:31.278 --> 00:27:37.200 and money supply does not 00:27:33.119 --> 00:27:37.199 change then what happens to the interest 00:27:38.398 --> 00:27:43.439 rate money demand goes up money supplies 00:27:41.960 --> 00:27:45.000 doesn't change what happens to the 00:27:43.440 --> 00:27:48.320 interest 00:27:45.000 --> 00:27:51.599 rate increases because at this interest 00:27:48.319 --> 00:27:54.798 rate here we have an excess demand for 00:27:51.599 --> 00:27:56.678 money so we have to reduce the money 00:27:54.798 --> 00:27:58.960 demand how do we reduce money Demand by 00:27:56.679 --> 00:28:01.919 increasing the interest rate 00:27:58.960 --> 00:28:04.480 that's way we so that's yet another 00:28:01.919 --> 00:28:07.559 reason why why it's not a good idea to 00:28:04.480 --> 00:28:09.319 be targeting monetary Aggregates the FED 00:28:07.558 --> 00:28:12.879 tells you we we want the interest rate 00:28:09.319 --> 00:28:14.639 at 5% say okay and then the economy will 00:28:12.880 --> 00:28:16.000 be growing and so on and what the FED 00:28:14.640 --> 00:28:17.960 will be doing is if they want to 00:28:16.000 --> 00:28:19.759 maintain the interest rate at 5% well 00:28:17.960 --> 00:28:22.840 they'll keep expanding M so the interest 00:28:19.759 --> 00:28:25.480 rate doesn't go up okay that's the way 00:28:22.839 --> 00:28:27.678 normally conduct but if the if the FED 00:28:25.480 --> 00:28:30.319 stays sleepy and and and you have an 00:28:27.679 --> 00:28:33.360 increasing many demand then then the 00:28:30.319 --> 00:28:33.359 interest will tend to go 00:28:35.480 --> 00:28:44.159 up so I told you that that 00:28:40.200 --> 00:28:45.759 ER that the central bank is moving M 00:28:44.159 --> 00:28:47.919 increasing them reducing them or 00:28:45.759 --> 00:28:50.000 whatever so how do they do 00:28:47.919 --> 00:28:52.880 that I 00:28:50.000 --> 00:28:55.000 mean it's not that they although that 00:28:52.880 --> 00:28:57.278 police has been advocated it's not that 00:28:55.000 --> 00:28:59.720 they go in a helicopter and sort of fly 00:28:57.278 --> 00:29:02.038 bills on top of all of us they don't do 00:28:59.720 --> 00:29:03.960 that although again it has been 00:29:02.038 --> 00:29:06.119 advocated in extreme cases of recessions 00:29:03.960 --> 00:29:10.319 and so on and it's called helicopter 00:29:06.119 --> 00:29:12.639 money just give money away okay 00:29:10.319 --> 00:29:14.639 ER but that's not the way it's normally 00:29:12.640 --> 00:29:17.600 done for normal operations is not done 00:29:14.640 --> 00:29:19.200 that way so how is it done remember that 00:29:17.599 --> 00:29:22.879 we have a financial system that is very 00:29:19.200 --> 00:29:25.399 simple for now we have money and bonds 00:29:22.880 --> 00:29:26.480 so what the Central Bank does the 00:29:25.398 --> 00:29:27.639 Central Bank wants to change the 00:29:26.480 --> 00:29:29.839 portfolio of people that they want 00:29:27.640 --> 00:29:31.759 people to have less bonds say and more 00:29:29.839 --> 00:29:33.599 money that's when that's to ruce the 00:29:31.759 --> 00:29:36.079 interest rate so what the Central Bank 00:29:33.599 --> 00:29:38.158 does is goes up there and expansionary 00:29:36.079 --> 00:29:40.119 open market operation open market is 00:29:38.159 --> 00:29:44.640 because they go into the open market to 00:29:40.119 --> 00:29:46.839 buy bonds okay they as as opposed to an 00:29:44.640 --> 00:29:48.240 operation that happens behind doors if 00:29:46.839 --> 00:29:50.038 the if the FED went directly to the 00:29:48.240 --> 00:29:52.519 treasury and bought bonds that would not 00:29:50.038 --> 00:29:54.119 be an open market operation okay but 00:29:52.519 --> 00:29:56.599 what they do is they go to financial 00:29:54.119 --> 00:30:00.639 their financial system and they go with 00:29:56.599 --> 00:30:04.199 a big bag of money and say okay we want 00:30:00.640 --> 00:30:08.000 bones and so the public sells bones to 00:30:04.200 --> 00:30:10.480 them in exchange for money okay that's 00:30:08.000 --> 00:30:13.359 an expansion in market so what we saw 00:30:10.480 --> 00:30:15.839 that before when M shift to the right 00:30:13.359 --> 00:30:18.240 what the central bank really did is went 00:30:15.839 --> 00:30:20.599 out there and bought bonds from the 00:30:18.240 --> 00:30:24.200 public the public sold the 00:30:20.599 --> 00:30:26.439 bonds and got the cash okay at some 00:30:24.200 --> 00:30:27.720 price people when when I show you 00:30:26.440 --> 00:30:29.080 equilibrium in the money market that 00:30:27.720 --> 00:30:32.120 means also an equilibrium in the bond 00:30:29.079 --> 00:30:34.639 market necessarily so it has to be that 00:30:32.119 --> 00:30:36.558 the price is right for the for the 00:30:34.640 --> 00:30:38.320 portfolio of individuals a 00:30:36.558 --> 00:30:40.240 contractionary open market operation is 00:30:38.319 --> 00:30:43.319 the opposite is a central bank goes out 00:30:40.240 --> 00:30:45.798 there and sells bonds to the market and 00:30:43.319 --> 00:30:47.720 takes the cash back okay that's a 00:30:45.798 --> 00:30:49.918 contractionary monetary policy so when 00:30:47.720 --> 00:30:52.120 the FED wants to yeah when the FED let 00:30:49.919 --> 00:30:54.759 me justew when the FED wants to cut 00:30:52.119 --> 00:30:57.119 interest rate what the FED does is an 00:30:54.759 --> 00:30:59.000 expansion in monetary policy which means 00:30:57.119 --> 00:31:01.798 it goes out there and buys bonds from 00:30:59.000 --> 00:31:04.159 the market and gives cash to the market 00:31:01.798 --> 00:31:06.038 yeah can how can the Central Banking 00:31:04.159 --> 00:31:08.399 assistance guarantee that some's apply 00:31:06.038 --> 00:31:09.798 their bonds like if they didn't have if 00:31:08.398 --> 00:31:12.079 their government didn't have the 00:31:09.798 --> 00:31:13.759 financial stability I guess the like 00:31:12.079 --> 00:31:16.199 United States has how would they 00:31:13.759 --> 00:31:18.158 guarantee that these bonds will be worth 00:31:16.200 --> 00:31:20.000 anything in the long well I mean there's 00:31:18.159 --> 00:31:21.480 you're talking about risk premium and 00:31:20.000 --> 00:31:25.000 that's a that's 00:31:21.480 --> 00:31:28.480 that's that's an an additional issue 00:31:25.000 --> 00:31:31.480 typically a a central banks inter 00:31:28.480 --> 00:31:34.159 in in in in very short duration bonds so 00:31:31.480 --> 00:31:36.639 there it's not the typical bond that is 00:31:34.159 --> 00:31:39.440 risky in many sense it's very very very 00:31:36.638 --> 00:31:42.519 short duration bonds treasuries very 00:31:39.440 --> 00:31:44.240 short duration in fact it's even less 00:31:42.519 --> 00:31:48.440 nowadays central banks really intervene 00:31:44.240 --> 00:31:50.319 in the in the overnight Market is is but 00:31:48.440 --> 00:31:52.278 but you're right that that countries 00:31:50.319 --> 00:31:54.678 that don't have a bond market a 00:31:52.278 --> 00:31:56.200 well-developed market have problems with 00:31:54.679 --> 00:31:57.360 the management of monetary policy and so 00:31:56.200 --> 00:31:59.240 on because they have a cretive spread 00:31:57.359 --> 00:32:00.599 that is moving around around as well but 00:31:59.240 --> 00:32:02.399 they tend to focus on the type of 00:32:00.599 --> 00:32:05.558 instruments that thing becomes very 00:32:02.398 --> 00:32:07.879 important I mean for Japan even big guys 00:32:05.558 --> 00:32:10.558 very big guys now they have an issue 00:32:07.880 --> 00:32:13.200 because they have been buying bonds very 00:32:10.558 --> 00:32:16.119 long duration bonds 10 year bonds and 00:32:13.200 --> 00:32:17.919 stuff like that and there it's a little 00:32:16.119 --> 00:32:19.719 trickier Market need to trust you a lot 00:32:17.919 --> 00:32:21.440 more if you're dealing with 10e things 00:32:19.720 --> 00:32:23.600 and you're dealing with a three-month 00:32:21.440 --> 00:32:28.840 Horizons and so 00:32:23.599 --> 00:32:31.398 on in other instances a um 00:32:28.839 --> 00:32:33.638 erh for example Chile has a situation 00:32:31.398 --> 00:32:36.599 like that the Central Bank itself can 00:32:33.638 --> 00:32:38.638 issue bonds and so those are bonds 00:32:36.599 --> 00:32:40.879 issued by the central banks and they 00:32:38.638 --> 00:32:42.158 tend to be very reliable bonds because 00:32:40.880 --> 00:32:43.880 these are bonds that are issuing your 00:32:42.159 --> 00:32:45.399 same currency so you have the currency 00:32:43.880 --> 00:32:48.120 to always pay the you can always print 00:32:45.398 --> 00:32:50.079 money and pay for those bonds you see so 00:32:48.119 --> 00:32:53.158 it rarely happens that there is default 00:32:50.079 --> 00:32:56.278 on bonds of that kind 00:32:53.159 --> 00:33:00.000 ER the typical bonds government bond 00:32:56.278 --> 00:33:01.440 that defaults is a bond that is issuing 00:33:00.000 --> 00:33:03.079 a currency different from the one you 00:33:01.440 --> 00:33:04.919 have because then you may not have the 00:33:03.079 --> 00:33:07.398 currency to pay for stu okay and that's 00:33:04.919 --> 00:33:09.799 the reason em markets run into trouble 00:33:07.398 --> 00:33:12.439 and things of that kind 00:33:09.798 --> 00:33:14.319 okay so in terms of the balance sheet of 00:33:12.440 --> 00:33:17.080 the Central Bank how does an open market 00:33:14.319 --> 00:33:18.519 operation look so if you look at the at 00:33:17.079 --> 00:33:20.199 the balance sheet this is an incredibly 00:33:18.519 --> 00:33:23.000 simplified version of the balance sheet 00:33:20.200 --> 00:33:25.440 of the of the FED no they have lots of 00:33:23.000 --> 00:33:28.798 things some more assets gold and all 00:33:25.440 --> 00:33:32.038 sort of stuff but in our simple economy 00:33:28.798 --> 00:33:34.079 the government the the fed the assets of 00:33:32.038 --> 00:33:36.278 the feds is they have some bonds it has 00:33:34.079 --> 00:33:38.519 already some bonds out there and the 00:33:36.278 --> 00:33:40.278 liabilities is the money they issue they 00:33:38.519 --> 00:33:42.480 owe that to people I mean they issue 00:33:40.278 --> 00:33:43.798 currency but you know but but that's 00:33:42.480 --> 00:33:46.159 it's a 00:33:43.798 --> 00:33:47.720 liability people can do things with can 00:33:46.159 --> 00:33:49.840 buy things with that money and so it's a 00:33:47.720 --> 00:33:52.919 liability so that's the way the balance 00:33:49.839 --> 00:33:55.638 sheet looks so when when the the FED 00:33:52.919 --> 00:33:59.679 decides to do an expansionary open 00:33:55.638 --> 00:34:03.398 market operation then what it does is it 00:33:59.679 --> 00:34:06.240 goes out there it IT issues an say a $1 00:34:03.398 --> 00:34:08.000 million expansionary open market 00:34:06.240 --> 00:34:10.480 operation they do it in much we get 00:34:08.000 --> 00:34:13.239 tickets on this but let's make it simple 00:34:10.480 --> 00:34:15.719 $1 million of an expansionary operation 00:34:13.239 --> 00:34:18.638 but they go they go out there they they 00:34:15.719 --> 00:34:22.078 print a million dollars and they buy a 00:34:18.639 --> 00:34:25.960 million dollars from the market okay and 00:34:22.079 --> 00:34:28.240 so at the end the balance sheet ends 00:34:25.960 --> 00:34:30.800 like it used to be the there's an extra 00:34:28.239 --> 00:34:32.719 $1 million of liabilities because now 00:34:30.800 --> 00:34:36.079 there's a million more of dollars 00:34:32.719 --> 00:34:38.039 circulating out there and but but the 00:34:36.079 --> 00:34:42.079 against that the Central Bank also has a 00:34:38.039 --> 00:34:44.878 million more of bonds Holdings 00:34:42.079 --> 00:34:47.320 okay so that's that's what happens with 00:34:44.878 --> 00:34:49.199 when so so when in an expansionary 00:34:47.320 --> 00:34:51.559 monetary policy the balance sheet of the 00:34:49.199 --> 00:34:55.239 Central Bank expands both sides expand 00:34:51.559 --> 00:34:58.559 by the same amount okay but expands and 00:34:55.239 --> 00:34:59.919 one of the big themes of recent years 00:34:58.559 --> 00:35:02.719 starting from the global financial 00:34:59.920 --> 00:35:05.320 crisis is that these balance sheets used 00:35:02.719 --> 00:35:07.000 to be small peanuts type things for I 00:35:05.320 --> 00:35:09.720 mean a trillion dollar or something like 00:35:07.000 --> 00:35:12.480 that for something like the the US the 00:35:09.719 --> 00:35:14.159 size nowadays they're much much larger 00:35:12.480 --> 00:35:15.719 than that because they have done so many 00:35:14.159 --> 00:35:17.279 operations to first get us out of the 00:35:15.719 --> 00:35:19.279 global financial crisis and then to get 00:35:17.280 --> 00:35:20.800 us out of covid and so on that these 00:35:19.280 --> 00:35:23.440 balance sheets are 00:35:20.800 --> 00:35:25.599 now an order or two orders of magnitude 00:35:23.440 --> 00:35:28.920 larger than they used to be 00:35:25.599 --> 00:35:31.440 okay but be in words they have had to do 00:35:28.920 --> 00:35:35.559 lots of expansionary monetary policy 00:35:31.440 --> 00:35:35.559 over the last couple of decades or 00:35:37.440 --> 00:35:43.920 so so let me talk about a little bit 00:35:40.838 --> 00:35:46.000 about interest rate and bond prices 00:35:43.920 --> 00:35:49.519 because that's the other side of this 00:35:46.000 --> 00:35:50.838 thing so so what is the connection 00:35:49.519 --> 00:35:52.199 because sometimes it's easier to 00:35:50.838 --> 00:35:56.440 understand things in terms of price in 00:35:52.199 --> 00:35:58.838 terms of bonds so suppose a bond pays 00:35:56.440 --> 00:36:00.920 $100 a year from now and and no coupon 00:35:58.838 --> 00:36:05.000 in between so if you buy a bond now for 00:36:00.920 --> 00:36:07.680 some price PB you get $100 a year from 00:36:05.000 --> 00:36:09.920 now so what is the interest rate of that 00:36:07.679 --> 00:36:11.480 bond that is what is the excess return 00:36:09.920 --> 00:36:13.358 that you get out of that or the return 00:36:11.480 --> 00:36:17.000 you get out of buying that 00:36:13.358 --> 00:36:20.159 Bond well it's going to be $100 minus 00:36:17.000 --> 00:36:23.679 whatever you pay today say you pay 95 00:36:20.159 --> 00:36:26.598 then $5 divided by your investment 00:36:23.679 --> 00:36:29.279 initial investment which was 95 okay so 00:36:26.599 --> 00:36:32.760 that's a bond that gives you know a 00:36:29.280 --> 00:36:34.000 little bit more than 5% in a year okay 00:36:32.760 --> 00:36:35.960 that's a return that's interesting so 00:36:34.000 --> 00:36:38.838 that's a connection between interest 00:36:35.960 --> 00:36:40.000 rate and prices and notice that this is 00:36:38.838 --> 00:36:43.279 an inverse 00:36:40.000 --> 00:36:46.159 relation you know when the price of a 00:36:43.280 --> 00:36:47.640 bond goes up the interest rate pay goes 00:36:46.159 --> 00:36:49.399 down because you're paying more for the 00:36:47.639 --> 00:36:51.559 same principle you're going to get 100 00:36:49.400 --> 00:36:52.760 but now you're paying more for it well 00:36:51.559 --> 00:36:56.039 that means the interest rate the return 00:36:52.760 --> 00:36:58.319 on that Bond went down 00:36:56.039 --> 00:37:00.000 okay conversion you can say the other 00:36:58.318 --> 00:37:01.759 way around the higher is the interest 00:37:00.000 --> 00:37:04.119 rate the lower is the price of bond of a 00:37:01.760 --> 00:37:05.680 bond so for example today the interest 00:37:04.119 --> 00:37:09.760 rate is 00:37:05.679 --> 00:37:11.639 5% a ER if I want to issue a bond that 00:37:09.760 --> 00:37:15.040 doesn't pay any coupon and I'm 00:37:11.639 --> 00:37:16.358 completely safe so I'm the US Treasury 00:37:15.039 --> 00:37:18.159 I'm going to be able to sell that bone 00:37:16.358 --> 00:37:20.559 for 00:37:18.159 --> 00:37:21.598 95 two years ago when the interest rate 00:37:20.559 --> 00:37:23.639 was 00:37:21.599 --> 00:37:26.160 Zero the fair would have been able to 00:37:23.639 --> 00:37:28.078 sell that bond for 00:37:26.159 --> 00:37:29.440 100 okay 00:37:28.079 --> 00:37:30.880 so there's an inverse relationship 00:37:29.440 --> 00:37:34.200 between the interest rate and the price 00:37:30.880 --> 00:37:36.720 of bonds and now I can take you back to 00:37:34.199 --> 00:37:38.039 my open market operation so remember 00:37:36.719 --> 00:37:40.480 what what I said there's another way of 00:37:38.039 --> 00:37:42.838 remembering sort of which way these 00:37:40.480 --> 00:37:44.760 signs go remember when you have an 00:37:42.838 --> 00:37:46.318 expansionary monetary operation I said 00:37:44.760 --> 00:37:49.680 the FED goes out there with a back of 00:37:46.318 --> 00:37:52.119 money and buys bonds from the market 00:37:49.679 --> 00:37:53.719 when bonds when you buy something when 00:37:52.119 --> 00:37:55.000 there's an enormous increase in demand 00:37:53.719 --> 00:37:58.078 for something what do you think happens 00:37:55.000 --> 00:38:00.880 to the price of that something 00:37:58.079 --> 00:38:03.680 goes up no for anything cars whatever it 00:38:00.880 --> 00:38:07.039 is if there's a lot more demand then 00:38:03.679 --> 00:38:10.919 prices will go up and the FED has a lot 00:38:07.039 --> 00:38:13.199 of cash so he can really buy large 00:38:10.920 --> 00:38:15.760 amount of bonds and so when the FED goes 00:38:13.199 --> 00:38:17.639 out there and does an expansionary open 00:38:15.760 --> 00:38:19.880 market operation means it goes out there 00:38:17.639 --> 00:38:21.879 and buys a lot of bonds the price of 00:38:19.880 --> 00:38:23.400 those bonds goes up and made that 00:38:21.880 --> 00:38:25.960 formula that means the interest rate is 00:38:23.400 --> 00:38:27.960 going down okay so that's another way of 00:38:25.960 --> 00:38:30.720 understanding how is it 00:38:27.960 --> 00:38:32.318 expansion open market operation lowers 00:38:30.719 --> 00:38:34.639 the interest rate it's because it raises 00:38:32.318 --> 00:38:36.639 the price of the bonds that is 00:38:34.639 --> 00:38:40.239 demanding and when you raise the price 00:38:36.639 --> 00:38:40.239 of the bonds then the interest rate goes 00:38:43.800 --> 00:38:51.800 down will I do this to 00:38:47.039 --> 00:38:53.519 you well very quickly so really the only 00:38:51.800 --> 00:38:55.760 thing I really care I want you to 00:38:53.519 --> 00:38:58.000 understand what I what I just said well 00:38:55.760 --> 00:39:00.480 because we're going to use it 00:38:58.000 --> 00:39:03.440 I want to you to understand what comes 00:39:00.480 --> 00:39:05.920 next ideally well but but it's okay if 00:39:03.440 --> 00:39:06.880 you don't understand it too well okay 00:39:05.920 --> 00:39:08.440 and I'm going to tell you when do you 00:39:06.880 --> 00:39:11.318 have to start understanding very well 00:39:08.440 --> 00:39:14.039 again okay for now this this is a pie in 00:39:11.318 --> 00:39:16.639 qu is what I'm doing here is making 00:39:14.039 --> 00:39:19.239 things a little bit more realistic the 00:39:16.639 --> 00:39:21.440 the message will be similar but it's a 00:39:19.239 --> 00:39:23.559 little bit more complicated okay and 00:39:21.440 --> 00:39:26.480 that's the reason sort of 00:39:23.559 --> 00:39:28.279 substantively H um I already told you 00:39:26.480 --> 00:39:29.960 what I wanted to tell you 00:39:28.280 --> 00:39:31.359 what I'm going to tell you now will give 00:39:29.960 --> 00:39:32.760 you a little bit more realism and 00:39:31.358 --> 00:39:34.358 therefore will allow you to understand a 00:39:32.760 --> 00:39:36.720 little bit 00:39:34.358 --> 00:39:39.159 better a technical description of 00:39:36.719 --> 00:39:40.358 monetary policy or something like that 00:39:39.159 --> 00:39:43.078 so in 00:39:40.358 --> 00:39:45.000 practice you know in the economy I just 00:39:43.079 --> 00:39:48.240 describe you had sort of households and 00:39:45.000 --> 00:39:50.079 firms and the central bank but in 00:39:48.239 --> 00:39:52.318 practice there are lot of financial 00:39:50.079 --> 00:39:54.680 intermediaries okay and in financial 00:39:52.318 --> 00:39:56.358 intermed the most prominent of them for 00:39:54.679 --> 00:39:58.519 especially for monetary policy are the 00:39:56.358 --> 00:39:59.719 banks and there are certain Banks 00:39:58.519 --> 00:40:02.318 actually they're even more important 00:39:59.719 --> 00:40:04.598 than others but banks are financially 00:40:02.318 --> 00:40:07.519 intim intimidates they take money from 00:40:04.599 --> 00:40:09.039 someone or deposit from someone and lend 00:40:07.519 --> 00:40:11.920 it to someone else or buy some 00:40:09.039 --> 00:40:13.960 instruments okay so so they intermediate 00:40:11.920 --> 00:40:16.559 the funds of somebody that wants to save 00:40:13.960 --> 00:40:19.119 on in the bank a deposit in a deposit 00:40:16.559 --> 00:40:19.920 account or something and they they lend 00:40:19.119 --> 00:40:22.200 that 00:40:19.920 --> 00:40:28.280 money effectively in the name of the 00:40:22.199 --> 00:40:32.000 other person to H someone else okay so 00:40:28.280 --> 00:40:35.519 Banks do two things to the model I just 00:40:32.000 --> 00:40:36.719 described the first is that they produce 00:40:35.519 --> 00:40:38.318 money as 00:40:36.719 --> 00:40:40.039 well 00:40:38.318 --> 00:40:43.279 okay 00:40:40.039 --> 00:40:45.599 because ER money is made of currency 00:40:43.280 --> 00:40:48.680 which is is issued by the central bank 00:40:45.599 --> 00:40:51.000 but it's also made of a checkable 00:40:48.679 --> 00:40:53.519 deposits if you have a a checking 00:40:51.000 --> 00:40:56.639 account something you can have a debit 00:40:53.519 --> 00:40:59.880 card against or something like that then 00:40:56.639 --> 00:41:02.078 then that's money for you okay if you 00:40:59.880 --> 00:41:07.079 deposit in a bank in a checking 00:41:02.079 --> 00:41:09.280 account that's money okay and so when 00:41:07.079 --> 00:41:12.119 Banks the liabilities of banks the 00:41:09.280 --> 00:41:13.599 deposits is part of money it's something 00:41:12.119 --> 00:41:15.160 you can use for transactions you can 00:41:13.599 --> 00:41:17.559 write checks you can use your debit card 00:41:15.159 --> 00:41:20.960 and stuff like that okay so that's the 00:41:17.559 --> 00:41:22.318 first thing that Banks do okay the other 00:41:20.960 --> 00:41:23.920 thing the banks 00:41:22.318 --> 00:41:27.400 do 00:41:23.920 --> 00:41:29.760 is they themselves have a deposit 00:41:27.400 --> 00:41:34.480 account at the Central 00:41:29.760 --> 00:41:37.359 Bank okay so they themselves take part 00:41:34.480 --> 00:41:39.240 of the deposits they take the deposits 00:41:37.358 --> 00:41:41.719 part of the deposit they lend to other 00:41:39.239 --> 00:41:43.959 people another part they buy financial 00:41:41.719 --> 00:41:46.480 instruments Bond and stuff like that in 00:41:43.960 --> 00:41:49.440 this economy would be only bonds and the 00:41:46.480 --> 00:41:53.480 other part smaller part 10% or something 00:41:49.440 --> 00:41:55.960 like that they deposit at the central 00:41:53.480 --> 00:41:58.358 bank that deposit at the central bank is 00:41:55.960 --> 00:42:01.358 called Reserves 00:41:58.358 --> 00:42:04.358 okay so when you he the word reserves of 00:42:01.358 --> 00:42:07.199 the banking sector this is the deposits 00:42:04.358 --> 00:42:10.639 of the banks at the Central 00:42:07.199 --> 00:42:11.960 Bank okay and that's that's also 00:42:10.639 --> 00:42:13.719 liability for the Central Bank the 00:42:11.960 --> 00:42:15.440 central bank is holding that deposit of 00:42:13.719 --> 00:42:17.598 the banks it's not the central bank's 00:42:15.440 --> 00:42:19.599 money it's the it's the bank's money 00:42:17.599 --> 00:42:22.318 okay and they're holding it there it's a 00:42:19.599 --> 00:42:22.318 liability as 00:42:22.480 --> 00:42:27.960 well so now if you look at how the 00:42:25.760 --> 00:42:30.680 balance sheets look 00:42:27.960 --> 00:42:33.679 our central bank now has more things he 00:42:30.679 --> 00:42:35.960 has assets going to be Bonds in this 00:42:33.679 --> 00:42:38.480 economy this only thing you can have but 00:42:35.960 --> 00:42:40.960 now it will have the currency that had 00:42:38.480 --> 00:42:42.920 before and in liabilities but also will 00:42:40.960 --> 00:42:46.720 have the Reserves the deposits of the 00:42:42.920 --> 00:42:46.720 banks themselves 00:42:48.880 --> 00:42:54.680 okay okay and this is called this stuff 00:42:51.800 --> 00:42:56.519 here is called central bank money in 00:42:54.679 --> 00:42:57.799 contrast it is called Central Bank it 00:42:56.519 --> 00:42:59.800 has so many names 00:42:57.800 --> 00:43:01.280 it's called central bank money high 00:42:59.800 --> 00:43:04.599 power 00:43:01.280 --> 00:43:07.440 money some other name have some but but 00:43:04.599 --> 00:43:09.240 but he has several names and what is I I 00:43:07.440 --> 00:43:11.679 like the name central bank money because 00:43:09.239 --> 00:43:13.279 that's in contrast with this kind of 00:43:11.679 --> 00:43:16.000 money it's the money that the banking 00:43:13.280 --> 00:43:18.119 sector produces the checkable deposits 00:43:16.000 --> 00:43:20.599 okay so this is the money produced by 00:43:18.119 --> 00:43:22.920 the central bank and then the and then 00:43:20.599 --> 00:43:25.800 through deposits the financial system 00:43:22.920 --> 00:43:28.880 the banks themselves produce more 00:43:25.800 --> 00:43:32.240 money so The Total Money in the system 00:43:28.880 --> 00:43:35.318 is much more than the central bank money 00:43:32.239 --> 00:43:39.199 because deposits is a big thing you 00:43:35.318 --> 00:43:43.119 know this is much larger than that in 00:43:39.199 --> 00:43:46.159 practice okay good how does this change 00:43:43.119 --> 00:43:47.400 our mold not really much and so so again 00:43:46.159 --> 00:43:50.000 that's the reason I don't care too much 00:43:47.400 --> 00:43:53.119 if you understand these last two slides 00:43:50.000 --> 00:43:56.559 so let me rederive what we 00:43:53.119 --> 00:43:59.599 have with this approach with with this 00:43:56.559 --> 00:44:01.839 this uh extension so money demand is the 00:43:59.599 --> 00:44:03.079 same as it used to be what happens is 00:44:01.838 --> 00:44:04.719 you're going to demand it in the form of 00:44:03.079 --> 00:44:06.119 currency or checking accounts or 00:44:04.719 --> 00:44:09.799 something like that but but the total 00:44:06.119 --> 00:44:15.240 money demand is exactly as it used to 00:44:09.800 --> 00:44:16.920 be Banks typically hold a share of a and 00:44:15.239 --> 00:44:18.919 assume for now that there's no currency 00:44:16.920 --> 00:44:20.440 so everything is check is deposit 00:44:18.920 --> 00:44:23.800 otherwise you get a more complicated 00:44:20.440 --> 00:44:26.200 formula okay so no one holds cash which 00:44:23.800 --> 00:44:28.318 probably quite realistic nowadays you so 00:44:26.199 --> 00:44:30.439 everyone has a checking account and 00:44:28.318 --> 00:44:33.239 that's it 00:44:30.440 --> 00:44:36.599 okay 00:44:33.239 --> 00:44:40.558 so the banks 00:44:36.599 --> 00:44:42.599 typically hold for regulatory reasons a 00:44:40.559 --> 00:44:45.599 share of their Deposit they have a 00:44:42.599 --> 00:44:48.039 minimum for regulatory reasons a minimum 00:44:45.599 --> 00:44:50.400 share of the deposit they have that they 00:44:48.039 --> 00:44:52.239 need to hold in the form of reserves 00:44:50.400 --> 00:44:55.960 okay and I'm going to call that a fixed 00:44:52.239 --> 00:44:58.879 fraction Theta so if all the money is 00:44:55.960 --> 00:45:01.960 held in the form of the deposits then 00:44:58.880 --> 00:45:05.160 Theta which is a number like 0.1 say 00:45:01.960 --> 00:45:08.760 times the deposits which is money demand 00:45:05.159 --> 00:45:10.639 is equal to the reserves at the is equal 00:45:08.760 --> 00:45:11.520 to the central the demand for central 00:45:10.639 --> 00:45:13.679 bank 00:45:11.519 --> 00:45:16.119 money this is the demand for central 00:45:13.679 --> 00:45:17.960 bank money because is this are the N 00:45:16.119 --> 00:45:20.760 these are the reserves that the banks 00:45:17.960 --> 00:45:22.280 want to have at the central bank so the 00:45:20.760 --> 00:45:24.760 demand they they want to have this 00:45:22.280 --> 00:45:28.480 amount of deposits at the central bank 00:45:24.760 --> 00:45:30.319 this what we call HD it's Theta time m 00:45:28.480 --> 00:45:31.960 and so now rather than M what the 00:45:30.318 --> 00:45:34.039 Central Bank controls really because 00:45:31.960 --> 00:45:36.760 it's the only thing can really control 00:45:34.039 --> 00:45:39.558 is the money that it issues issues which 00:45:36.760 --> 00:45:42.319 is the central bank money so R supplying 00:45:39.559 --> 00:45:43.920 M which used to be currency now m is a 00:45:42.318 --> 00:45:46.159 bigger thing because has deposits and 00:45:43.920 --> 00:45:48.240 all sort of stuff but the central bank 00:45:46.159 --> 00:45:50.480 is the one that controls how much high 00:45:48.239 --> 00:45:53.639 power money how much central bank money 00:45:50.480 --> 00:45:57.559 it issues and we're going to call that 00:45:53.639 --> 00:45:59.639 H okay so if we go back to my balance 00:45:57.559 --> 00:46:01.160 sheet here the Central Bank cannot 00:45:59.639 --> 00:46:03.039 control total money because it cannot 00:46:01.159 --> 00:46:06.399 control the amount of checkable deposits 00:46:03.039 --> 00:46:08.639 in the economy but it can control this 00:46:06.400 --> 00:46:10.920 money here and since we have no currency 00:46:08.639 --> 00:46:14.279 my example it really can control how 00:46:10.920 --> 00:46:16.039 much supply of reserves it can do okay 00:46:14.280 --> 00:46:17.400 and so now we have a demand for Reserve 00:46:16.039 --> 00:46:20.199 which is just proportional to money 00:46:17.400 --> 00:46:22.960 demand equal to some fixed amount H 00:46:20.199 --> 00:46:24.719 which is the supply of high power money 00:46:22.960 --> 00:46:27.318 by the central bank and then the 00:46:24.719 --> 00:46:28.919 equilibrium looks exactly 00:46:27.318 --> 00:46:32.318 like before it's going to be some 00:46:28.920 --> 00:46:36.119 remember before we have m equal to 00:46:32.318 --> 00:46:39.800 Dollar y i now we're saying it's not M 00:46:36.119 --> 00:46:43.000 it's Theta times M really no because 00:46:39.800 --> 00:46:47.200 it's a fraction only of Total Money okay 00:46:43.000 --> 00:46:48.760 has to be equal to a money demand it's 00:46:47.199 --> 00:46:50.279 not Total Money demand it's the money 00:46:48.760 --> 00:46:52.640 demand that ends up being demand for 00:46:50.280 --> 00:46:55.599 central bank money because Total Money 00:46:52.639 --> 00:46:58.039 demand is the checkable checking 00:46:55.599 --> 00:47:00.440 account that leads to a demand for 00:46:58.039 --> 00:47:03.000 central bank money by the Banks which is 00:47:00.440 --> 00:47:04.358 Theta times those deposits it's not the 00:47:03.000 --> 00:47:05.838 full Deposit they don't Deposit they 00:47:04.358 --> 00:47:07.480 don't take all the deposit and deposit 00:47:05.838 --> 00:47:09.279 at Central Bank they say only 10% of 00:47:07.480 --> 00:47:12.760 those deposit will keep them at the 00:47:09.280 --> 00:47:15.720 central bank so $100 in deposit if 30 is 00:47:12.760 --> 00:47:17.640 point1 $100 in deposit leads to a demand 00:47:15.719 --> 00:47:20.439 for reserves that mean for deposits by 00:47:17.639 --> 00:47:23.838 the bank and the Central Bank of 00:47:20.440 --> 00:47:26.280 $10 okay and that is the thing that the 00:47:23.838 --> 00:47:28.838 central bank can control very well it's 00:47:26.280 --> 00:47:31.280 a m the is the demand that comes to me 00:47:28.838 --> 00:47:34.400 the central bank is $10 and I decide 00:47:31.280 --> 00:47:35.720 whether we do $10 or not you we can do 00:47:34.400 --> 00:47:38.680 five and then we're going to have the 00:47:35.719 --> 00:47:41.598 interest rate sort out five to be in 00:47:38.679 --> 00:47:43.598 equilibrium so it's if if if the banking 00:47:41.599 --> 00:47:46.000 sector wanted 10 and I'm only going to 00:47:43.599 --> 00:47:48.680 supply five then something the interest 00:47:46.000 --> 00:47:51.280 rate is going to have to rise so that 00:47:48.679 --> 00:47:54.679 deposits you know decline less demand 00:47:51.280 --> 00:47:57.280 for money and and the and the final 00:47:54.679 --> 00:47:59.118 demand that gets to me is five not 10 00:47:57.280 --> 00:48:01.119 but the mechanism is exactly the same I 00:47:59.119 --> 00:48:03.240 know this this can be a little confusing 00:48:01.119 --> 00:48:06.160 but the mechanism exactly the same it's 00:48:03.239 --> 00:48:09.399 just this just illustrates it makes I 00:48:06.159 --> 00:48:09.399 mean this this is important 00:48:09.800 --> 00:48:14.680 because it's institutionally important 00:48:12.440 --> 00:48:16.200 more than conceptually important because 00:48:14.679 --> 00:48:17.440 this is the market where really the 00:48:16.199 --> 00:48:21.838 interest rate is 00:48:17.440 --> 00:48:24.000 set okay so this I'm doing next time 00:48:21.838 --> 00:48:25.920 that market the market for reserves 00:48:24.000 --> 00:48:27.280 really because what the banks do is they 00:48:25.920 --> 00:48:29.440 want Reserves 00:48:27.280 --> 00:48:31.280 okay deposit at the central bank that 00:48:29.440 --> 00:48:33.639 market for reserves the interest rate in 00:48:31.280 --> 00:48:36.200 that market for reserves is called the 00:48:33.639 --> 00:48:37.960 federal funds rate and it's called the 00:48:36.199 --> 00:48:40.519 federal funds rate because the Federal 00:48:37.960 --> 00:48:42.440 Reserves controls that rate so when the 00:48:40.519 --> 00:48:44.079 FED when when there is a meeting by the 00:48:42.440 --> 00:48:45.440 fed or a policy announcement that tell 00:48:44.079 --> 00:48:48.760 you that the the FED has increased the 00:48:45.440 --> 00:48:50.159 rate by 50 basis points it means it has 00:48:48.760 --> 00:48:54.400 increased the interest rate in that 00:48:50.159 --> 00:48:56.159 market by 50 basis points okay so the 00:48:54.400 --> 00:48:57.920 interest rate that the Central Bank 00:48:56.159 --> 00:49:01.078 controls corly is called the federal 00:48:57.920 --> 00:49:02.920 funds rate and the federal funds rate is 00:49:01.079 --> 00:49:05.280 that market is market for reserve for 00:49:02.920 --> 00:49:08.280 high power money so all the operations 00:49:05.280 --> 00:49:11.000 happen there they don't participate in 00:49:08.280 --> 00:49:13.040 the deposit Market or anything they 00:49:11.000 --> 00:49:15.000 participate in that market which every 00:49:13.039 --> 00:49:17.639 night is a is a Hu huge number of 00:49:15.000 --> 00:49:19.239 transactions every night because I put 00:49:17.639 --> 00:49:20.798 all the banks together but what happens 00:49:19.239 --> 00:49:22.199 every night is some banks have more 00:49:20.798 --> 00:49:24.318 reserves than they need some other banks 00:49:22.199 --> 00:49:26.358 have less reserves than they need so 00:49:24.318 --> 00:49:28.039 they supply and demand within the 00:49:26.358 --> 00:49:29.558 banking sector for for reserves and 00:49:28.039 --> 00:49:31.920 there's an interest rate that tends to 00:49:29.559 --> 00:49:33.680 equilibrate if too many banks are short 00:49:31.920 --> 00:49:34.880 reserves then there's going to be lots 00:49:33.679 --> 00:49:36.639 of demand for reserve and interest rate 00:49:34.880 --> 00:49:38.920 is going to tend to go up If the Fed 00:49:36.639 --> 00:49:40.838 doesn't want that interest rate to go up 00:49:38.920 --> 00:49:42.920 then what it will do overnight it will 00:49:40.838 --> 00:49:44.759 go there and inject reserves into the 00:49:42.920 --> 00:49:47.519 system high power money so the interest 00:49:44.760 --> 00:49:50.160 rate in that market comes down okay and 00:49:47.519 --> 00:49:51.880 that's the way the FED operates that's 00:49:50.159 --> 00:49:53.920 the way it controls it participates in 00:49:51.880 --> 00:49:57.200 that market controls the amount of high 00:49:53.920 --> 00:50:00.079 power money which regulates the rate in 00:49:57.199 --> 00:50:02.879 the resarch market and here it's only 00:50:00.079 --> 00:50:06.798 you know and then so here you have sort 00:50:02.880 --> 00:50:09.240 of the major Banks participating here 00:50:06.798 --> 00:50:10.759 and and and then this leaks into the 00:50:09.239 --> 00:50:13.479 other interest rates in the economy to 00:50:10.760 --> 00:50:15.760 into deposit rates to to bond rates and 00:50:13.480 --> 00:50:18.679 so on but but the real rate they control 00:50:15.760 --> 00:50:21.040 the rate that they control most directly 00:50:18.679 --> 00:50:22.318 is that rate here okay and that's the 00:50:21.039 --> 00:50:23.440 reason I wanted to give you a little bit 00:50:22.318 --> 00:50:26.239 of 00:50:23.440 --> 00:50:29.039 institutional I mean to add complexity 00:50:26.239 --> 00:50:29.039 so we could get 00:50:29.358 --> 00:50:34.159 to so you could get to this word federal 00:50:32.039 --> 00:50:36.719 funds rate because that's what you're 00:50:34.159 --> 00:50:38.480 going to read in the newspapers the FED 00:50:36.719 --> 00:50:39.798 increase the federal funds Target is 00:50:38.480 --> 00:50:41.159 going to say because they target they 00:50:39.798 --> 00:50:42.719 cannot guarantee it's going to be that 00:50:41.159 --> 00:50:44.318 they target an interest rate and 00:50:42.719 --> 00:50:49.000 typically they give you a range it's a 00:50:44.318 --> 00:50:51.119 very narrow range okay you let me just 00:50:49.000 --> 00:50:55.519 conclude by showing you how that rate 00:50:51.119 --> 00:51:00.119 has looked in the US recently okay and I 00:50:55.519 --> 00:51:02.679 finish here so here here is before covid 00:51:00.119 --> 00:51:04.798 okay H the interest rate the Fed was 00:51:02.679 --> 00:51:06.598 already hik in interest rate it had 00:51:04.798 --> 00:51:08.559 overdone it there so it was beginning to 00:51:06.599 --> 00:51:10.760 lower interest rate and then covid came 00:51:08.559 --> 00:51:13.000 boom and they cut interest rate very 00:51:10.760 --> 00:51:14.160 aggressively the this is the maximum 00:51:13.000 --> 00:51:15.639 they can cut it too and we're going to 00:51:14.159 --> 00:51:18.078 talk about that briefly in the next to 00:51:15.639 --> 00:51:20.159 zero you cannot go below zero you cannot 00:51:18.079 --> 00:51:22.079 pay negative interest rate because then 00:51:20.159 --> 00:51:24.279 I don't demand money I don't demand 00:51:22.079 --> 00:51:26.318 bonds why should I hold a bond that pays 00:51:24.280 --> 00:51:28.280 me a negative interest rate when cash 00:51:26.318 --> 00:51:30.318 pays zero always zero I can always keep 00:51:28.280 --> 00:51:31.640 it under the mattress and and and I 00:51:30.318 --> 00:51:33.798 don't pay in negative so the interest 00:51:31.639 --> 00:51:35.199 rate the lowest can be zero and you see 00:51:33.798 --> 00:51:36.960 that they they did the maximum they 00:51:35.199 --> 00:51:39.039 could in terms of cutting interest rate 00:51:36.960 --> 00:51:40.559 they went to zero effectively zero and 00:51:39.039 --> 00:51:42.000 now they have been trying to catch up 00:51:40.559 --> 00:51:44.000 because inflation is very high and so 00:51:42.000 --> 00:51:46.039 they're trying to to hike interest rate 00:51:44.000 --> 00:51:48.039 and you see how what they're doing okay 00:51:46.039 --> 00:51:50.119 well all those interventions happen in 00:51:48.039 --> 00:51:52.480 the reserve Market that's what where 00:51:50.119 --> 00:51:56.039 this is that's the rate is in that 00:51:52.480 --> 00:51:59.679 market over okay okay so I think we're 00:51:56.039 --> 00:52:02.960 meeting on Tuesday next week uh I think 00:51:59.679 --> 00:52:02.960 that's the plan