WEBVTT 00:00:16.559 --> 00:00:21.118 okay so let's H let's continue with this 00:00:19.000 --> 00:00:24.800 islm model remember in the previous 00:00:21.118 --> 00:00:27.480 lecture we we set up we set it up we 00:00:24.800 --> 00:00:30.000 cons we built the eslm model I will go 00:00:27.480 --> 00:00:31.359 over that very quickly in this lecture 00:00:30.000 --> 00:00:34.159 because I think it's very important for 00:00:31.359 --> 00:00:35.440 you and then we're going to use it and 00:00:34.159 --> 00:00:38.238 uh eventually we're going to talk a 00:00:35.439 --> 00:00:41.519 little bit about the policy response the 00:00:38.238 --> 00:00:44.479 mcro macroeconomic policy response 00:00:41.520 --> 00:00:50.120 during the covid-19 00:00:44.479 --> 00:00:50.119 ER shock or recession all of the 00:00:51.359 --> 00:00:56.120 B so the the starting point remember 00:00:54.320 --> 00:00:59.359 with first thing we did we constructed 00:00:56.119 --> 00:01:02.358 the relation and the relation was just 00:00:59.359 --> 00:01:04.478 the same as lecture three but we sort of 00:01:02.359 --> 00:01:06.118 expel out what what is inside that 00:01:04.478 --> 00:01:08.759 investment that we had taken as a 00:01:06.118 --> 00:01:10.959 constant there we said well far more 00:01:08.759 --> 00:01:12.599 realistic is to make investment itself 00:01:10.959 --> 00:01:13.759 increasing in output because it's 00:01:12.599 --> 00:01:17.239 increasing in 00:01:13.759 --> 00:01:19.000 sales that in one change analysis that 00:01:17.239 --> 00:01:21.118 we had in lecture three all that will do 00:01:19.000 --> 00:01:22.759 is change the slope of the of the 00:01:21.118 --> 00:01:25.000 aggregate demand curve and therefore 00:01:22.759 --> 00:01:27.079 change the multiplier but we could have 00:01:25.000 --> 00:01:29.280 solved everything in terms of lecture 00:01:27.078 --> 00:01:31.399 three what made this a little different 00:01:29.280 --> 00:01:32.159 from lecture three is that we also said 00:01:31.400 --> 00:01:34.399 the 00:01:32.159 --> 00:01:35.439 investment real investment remember this 00:01:34.399 --> 00:01:37.560 has nothing to do with financial 00:01:35.438 --> 00:01:40.639 investment real investment is also a 00:01:37.560 --> 00:01:43.040 decreasing function of the interest rate 00:01:40.640 --> 00:01:47.079 okay and 00:01:43.040 --> 00:01:48.880 so er and and that led to the is 00:01:47.078 --> 00:01:51.758 relationship which essentially says 00:01:48.879 --> 00:01:53.959 these are all the is curve traces all 00:01:51.759 --> 00:01:55.879 the combinations of output and interest 00:01:53.959 --> 00:01:57.599 rate that are consistent with 00:01:55.879 --> 00:02:00.438 equilibrium in the Goods Market that's 00:01:57.599 --> 00:02:02.399 the definition of the now of course 00:02:00.438 --> 00:02:05.279 you know in in in lecture three we were 00:02:02.399 --> 00:02:07.079 able to determine equilibrium output 00:02:05.280 --> 00:02:10.560 here we 00:02:07.079 --> 00:02:10.560 can't why can't 00:02:17.878 --> 00:02:22.759 we yeah we have two unknowns it's output 00:02:20.959 --> 00:02:27.640 and the interest rate and we have only 00:02:22.759 --> 00:02:29.598 one relationship the is LM the curve so 00:02:27.639 --> 00:02:31.318 the reason for the LM curve is that we 00:02:29.598 --> 00:02:34.919 need pin down the second 00:02:31.318 --> 00:02:37.119 variable okay and that's what LM will do 00:02:34.919 --> 00:02:38.919 and it will be sort of very brutal about 00:02:37.120 --> 00:02:40.719 it in the past remember it was some 00:02:38.919 --> 00:02:42.318 upward slope in relationship I said in 00:02:40.719 --> 00:02:44.439 previously no that's not what the 00:02:42.318 --> 00:02:46.719 central banks do today just set the 00:02:44.439 --> 00:02:48.280 interest rate so if the Central Bank 00:02:46.719 --> 00:02:50.959 sets the interest rate then you can use 00:02:48.280 --> 00:02:52.919 lecture three to pin down equilibrium in 00:02:50.959 --> 00:02:55.560 the Goods Market which is what you would 00:02:52.919 --> 00:02:57.479 effectively be doing here if you fix 00:02:55.560 --> 00:02:59.840 this interest rate at whatever level the 00:02:57.479 --> 00:03:01.679 Central Bank wants then now you have one 00:02:59.840 --> 00:03:03.479 curve for one unknown which is output 00:03:01.680 --> 00:03:06.080 and that's exactly what we solve in 00:03:03.479 --> 00:03:08.079 lecture three 00:03:06.080 --> 00:03:12.080 okay 00:03:08.080 --> 00:03:14.719 good um so I said you know lecture three 00:03:12.080 --> 00:03:17.200 now this z z Curve will a little steeper 00:03:14.719 --> 00:03:19.598 because investment also responds 00:03:17.199 --> 00:03:21.919 positively to increases in 00:03:19.598 --> 00:03:24.079 output importantly now we have an 00:03:21.919 --> 00:03:26.598 interest rate which is a shifter of this 00:03:24.080 --> 00:03:28.519 aggregate demand in particular if the 00:03:26.598 --> 00:03:31.759 interest rate goes up what happens to 00:03:28.519 --> 00:03:31.760 that curve 00:03:34.919 --> 00:03:40.359 so if the interest rate goes up what 00:03:37.120 --> 00:03:40.360 happens to the AG demand 00:03:40.680 --> 00:03:45.640 curve I have two candidates here down or 00:03:46.318 --> 00:03:52.878 up down yeah because investment drops so 00:03:50.719 --> 00:03:54.280 you can tell me even more by how much if 00:03:52.878 --> 00:03:56.560 I tell you how much a change in the 00:03:54.280 --> 00:03:58.479 interest rate is and I tell you what is 00:03:56.560 --> 00:04:00.598 a sensitivity of investment to the 00:03:58.479 --> 00:04:02.280 interest rate you know exactly by how 00:04:00.598 --> 00:04:03.719 much this thing will come down it's 00:04:02.280 --> 00:04:05.519 going to be the change in the interest 00:04:03.719 --> 00:04:09.639 rate time the sensitivity of the 00:04:05.519 --> 00:04:11.920 investment function to to the interest 00:04:09.639 --> 00:04:13.598 rate that's not the end of the story as 00:04:11.919 --> 00:04:15.759 you well know that's the horizontal 00:04:13.598 --> 00:04:18.120 shift in a great demand but the final 00:04:15.759 --> 00:04:20.120 decline in output will be larger than 00:04:18.120 --> 00:04:22.399 that initial decline in investment as a 00:04:20.120 --> 00:04:24.600 result of the higher interest rate why 00:04:22.399 --> 00:04:24.599 is 00:04:25.600 --> 00:04:31.280 that 00:04:27.439 --> 00:04:34.879 so someone say the fed raises interest 00:04:31.279 --> 00:04:37.679 rate ER that immediately reduces 00:04:34.879 --> 00:04:39.839 investment because investment is 00:04:37.680 --> 00:04:41.800 negative related to the interest rate 00:04:39.839 --> 00:04:44.198 that immediately decreases aggregate 00:04:41.800 --> 00:04:45.918 demand which immediately increases 00:04:44.199 --> 00:04:48.639 decreases output because in this part of 00:04:45.918 --> 00:04:52.000 the course output is determined by agre 00:04:48.639 --> 00:04:54.918 demand does the adjustment stop 00:04:52.000 --> 00:04:57.360 there no that's what the multiplier was 00:04:54.918 --> 00:04:59.000 about because now with lower income 00:04:57.360 --> 00:05:01.240 there's lower consumption and actually 00:04:59.000 --> 00:05:03.680 lower investment as a result of that and 00:05:01.240 --> 00:05:06.759 we keep going okay so this the final 00:05:03.680 --> 00:05:08.959 Decline and output is a lot larger and 00:05:06.759 --> 00:05:10.759 doing that kind of experiment moving the 00:05:08.959 --> 00:05:13.239 interet around and seeing what happens 00:05:10.759 --> 00:05:18.000 to equilibrium output is that we derive 00:05:13.240 --> 00:05:22.240 we constructed the I curve okay that's 00:05:18.000 --> 00:05:23.759 here is for a cutting the inter no oh 00:05:22.240 --> 00:05:26.800 this is exactly the experiment I just 00:05:23.759 --> 00:05:29.160 describe so if you raise the interest 00:05:26.800 --> 00:05:30.960 rate then aggre demand comes down and 00:05:29.160 --> 00:05:32.319 then output declines buy a lot more than 00:05:30.959 --> 00:05:34.399 the initial decline in investment 00:05:32.319 --> 00:05:36.439 because of the multiplier but eventually 00:05:34.399 --> 00:05:39.000 we get to another equilibrium output 00:05:36.439 --> 00:05:40.918 which is that so now we know that this 00:05:39.000 --> 00:05:44.079 point belongs to the yes curve because 00:05:40.918 --> 00:05:46.439 it's a combination of output y Prime an 00:05:44.079 --> 00:05:48.079 interest rate I prime that is consistent 00:05:46.439 --> 00:05:50.519 with equilibrium in the Goods Market 00:05:48.079 --> 00:05:52.000 that's what lecture three told us that's 00:05:50.519 --> 00:05:54.198 what equilibrium in the goods markets 00:05:52.000 --> 00:05:55.038 look like that's another point of the 00:05:54.199 --> 00:05:58.840 same 00:05:55.038 --> 00:06:00.360 is H because I have higher output here 00:05:58.839 --> 00:06:01.719 lower interest rate straight that's 00:06:00.360 --> 00:06:04.400 another point of the as that's the 00:06:01.720 --> 00:06:06.880 reason this downward sloping look at 00:06:04.399 --> 00:06:10.198 what I just said I said I have another 00:06:06.879 --> 00:06:11.639 point of the same I how do I know it's 00:06:10.199 --> 00:06:15.400 the same 00:06:11.639 --> 00:06:15.400 as and not some other 00:06:18.160 --> 00:06:23.840 I you know all that I told you there is 00:06:20.879 --> 00:06:25.879 I found two points two combinations of 00:06:23.839 --> 00:06:27.318 output and interest rate that are 00:06:25.879 --> 00:06:29.598 consistent with equilibrium in the Goods 00:06:27.319 --> 00:06:31.120 Market but I said a little more I said 00:06:29.598 --> 00:06:34.079 and that's part that's the way we 00:06:31.120 --> 00:06:34.079 construct one 00:06:36.800 --> 00:06:40.918 is exactly because there is a lot of 00:06:39.478 --> 00:06:44.079 other parameters that we're keeping 00:06:40.918 --> 00:06:45.598 constant there you know that's the 00:06:44.079 --> 00:06:47.399 distinction between a movement along and 00:06:45.598 --> 00:06:49.399 is curve which is when the when the only 00:06:47.399 --> 00:06:52.318 thing I move is the interest rate that 00:06:49.399 --> 00:06:54.879 allows me to trace a movement along a 00:06:52.319 --> 00:06:58.120 single is if I move something else like 00:06:54.879 --> 00:07:00.680 taxes go on expenditure or autonomous 00:06:58.120 --> 00:07:03.280 consumption by you know something like 00:07:00.680 --> 00:07:04.879 that then I I will be Shifting the 00:07:03.279 --> 00:07:06.519 agregate demand for any given interest 00:07:04.879 --> 00:07:08.080 rate and I want to get a different level 00:07:06.519 --> 00:07:09.038 of output for any given interest rate 00:07:08.079 --> 00:07:11.038 which means I'm going to be in a 00:07:09.038 --> 00:07:14.159 different I 00:07:11.038 --> 00:07:17.000 okay and that's what we did there no in 00:07:14.160 --> 00:07:18.599 that case there we would said look I can 00:07:17.000 --> 00:07:20.360 fix the interest rate any interest rate 00:07:18.598 --> 00:07:22.159 you want let's pick this one but I could 00:07:20.360 --> 00:07:24.639 have done it other interest rate here 00:07:22.160 --> 00:07:27.400 there whatever and now I say what 00:07:24.639 --> 00:07:29.280 happens if I increase taxes well again 00:07:27.399 --> 00:07:31.120 you know from lecture three exactly what 00:07:29.279 --> 00:07:32.799 happen happens when the interest rate is 00:07:31.120 --> 00:07:34.120 constant because there we didn't even 00:07:32.800 --> 00:07:37.079 talk about the interest rate nothing was 00:07:34.120 --> 00:07:38.840 a function of the interest rate and you 00:07:37.079 --> 00:07:41.439 increase taxes well that will reduce 00:07:38.839 --> 00:07:46.000 disposable income for any level of 00:07:41.439 --> 00:07:47.598 output and H that um will lead to 00:07:46.000 --> 00:07:50.800 contraction our great demand output and 00:07:47.598 --> 00:07:53.079 so on so forth so that means that for 00:07:50.800 --> 00:07:56.038 this interest rate now I found another 00:07:53.079 --> 00:07:58.079 Point another point that is is an 00:07:56.038 --> 00:08:00.279 equilibrium in the Goods Market but it 00:07:58.079 --> 00:08:02.478 belongs to a different is because I move 00:08:00.279 --> 00:08:04.758 one of the parameters which is the taxes 00:08:02.478 --> 00:08:06.079 okay and now for this higher level of 00:08:04.759 --> 00:08:07.199 taxes I can play around with the 00:08:06.079 --> 00:08:09.478 interest rate I can say well what 00:08:07.199 --> 00:08:10.520 happens if I cut interest rate well if I 00:08:09.478 --> 00:08:13.639 cut interest rate I'm going to find 00:08:10.519 --> 00:08:15.038 another equilibrium say here if I cut 00:08:13.639 --> 00:08:17.759 the interest rate from here to here I'm 00:08:15.038 --> 00:08:19.199 going to find another equilibrium LEL of 00:08:17.759 --> 00:08:22.319 output which is consistent with that 00:08:19.199 --> 00:08:25.240 very same is why is that very same is 00:08:22.319 --> 00:08:28.000 well because I haven't moved taxes again 00:08:25.240 --> 00:08:30.199 okay so the reason I'm I'm repeating 00:08:28.000 --> 00:08:31.720 this is because I I it's very important 00:08:30.199 --> 00:08:36.240 to understand what what is a movement 00:08:31.720 --> 00:08:36.240 along the is versus what shift the 00:08:36.958 --> 00:08:42.079 is 00:08:38.679 --> 00:08:44.359 good then we move to the LM relation no 00:08:42.080 --> 00:08:46.160 and the LM relation is just equilibrium 00:08:44.360 --> 00:08:48.080 in the financial Market this is 00:08:46.159 --> 00:08:49.639 combinations of output and interest rate 00:08:48.080 --> 00:08:50.639 that are consistent with equilibrium in 00:08:49.639 --> 00:08:54.159 financial 00:08:50.639 --> 00:08:56.639 markets and we constructed from our 00:08:54.159 --> 00:08:58.799 money supply equal to money demand in 00:08:56.639 --> 00:09:00.039 nominal terms then we divide it by P 00:08:58.799 --> 00:09:01.879 which is not very interest in this part 00:09:00.039 --> 00:09:03.439 of the course because p is constant 00:09:01.879 --> 00:09:06.159 we're assuming that P is not moving 00:09:03.440 --> 00:09:08.000 that's the price of goods and services 00:09:06.159 --> 00:09:10.199 and then we have a this this this 00:09:08.000 --> 00:09:13.000 equilibrium here now stated in real 00:09:10.200 --> 00:09:16.600 terms so real money supply is equal to 00:09:13.000 --> 00:09:18.879 real money demand and as I said had you 00:09:16.600 --> 00:09:21.680 taken this course a few years back or 00:09:18.879 --> 00:09:23.120 perhaps in other places I don't know H 00:09:21.679 --> 00:09:25.039 that would have been an upward slop in 00:09:23.120 --> 00:09:26.759 relationship so the LM would have been 00:09:25.039 --> 00:09:29.000 an upward sloping relationship how do I 00:09:26.759 --> 00:09:30.679 know it's upward sloping well because if 00:09:29.000 --> 00:09:33.759 if I don't don't change money supply and 00:09:30.679 --> 00:09:37.679 I increase output then I need to bring 00:09:33.759 --> 00:09:39.919 Li down and since L Prime is negative 00:09:37.679 --> 00:09:41.759 the way to bring L down is by increasing 00:09:39.919 --> 00:09:45.120 the interest rate so that's what would 00:09:41.759 --> 00:09:47.360 have given you an upward sloping LM 00:09:45.120 --> 00:09:49.560 curve I said we don't do that now 00:09:47.360 --> 00:09:51.360 because really Bank central banks 00:09:49.559 --> 00:09:53.479 abandoned a long time ago in most parts 00:09:51.360 --> 00:09:56.720 of the world not everywhere this idea of 00:09:53.480 --> 00:09:58.639 targeting M what they target directly is 00:09:56.720 --> 00:10:01.600 the interest rate and then they give you 00:09:58.639 --> 00:10:04.159 whatever M they you need they need in 00:10:01.600 --> 00:10:05.480 order for the equilibrium in financial 00:10:04.159 --> 00:10:07.039 markets to be consistent with the 00:10:05.480 --> 00:10:10.800 interest rate the Central Bank wants to 00:10:07.039 --> 00:10:12.759 set okay so I said the modern is curve 00:10:10.799 --> 00:10:16.479 really looks like 00:10:12.759 --> 00:10:19.278 that the FED in the US Central Bank 00:10:16.480 --> 00:10:20.879 anywhere else sets the interest rate 00:10:19.278 --> 00:10:26.000 turkey is a little 00:10:20.879 --> 00:10:26.000 different but sets the interest rate 00:10:26.839 --> 00:10:33.560 ER and and and that's a a l now this 00:10:31.039 --> 00:10:35.439 this particular LM says I you know I 00:10:33.559 --> 00:10:37.599 it's a flat curve it's not a function of 00:10:35.440 --> 00:10:41.040 output the F sets the interest 00:10:37.600 --> 00:10:43.320 rate that's it that's the reason you 00:10:41.039 --> 00:10:45.679 know it's flat it's not upward slope or 00:10:43.320 --> 00:10:48.680 anything so I asked the question what 00:10:45.679 --> 00:10:48.679 shifts the modern 00:10:48.759 --> 00:10:53.159 LM only the central bank because the 00:10:51.759 --> 00:10:54.078 central bank is the one that sets the 00:10:53.159 --> 00:10:56.078 interest 00:10:54.078 --> 00:11:00.479 rate 00:10:56.078 --> 00:11:02.159 certainly well let me not complicate 00:11:00.480 --> 00:11:04.278 sets the interest rate so if the central 00:11:02.159 --> 00:11:06.199 bank doesn't change its mind then the 00:11:04.278 --> 00:11:11.519 interest rate is whatever it is and the 00:11:06.200 --> 00:11:13.320 LM will remain there okay good so we put 00:11:11.519 --> 00:11:15.078 the two things together and now we can 00:11:13.320 --> 00:11:17.120 pin down equilibrium output because 00:11:15.078 --> 00:11:19.120 remember we had when we just look at the 00:11:17.120 --> 00:11:20.360 is we had combinations of interest rate 00:11:19.120 --> 00:11:22.519 and output that were consistent with 00:11:20.360 --> 00:11:24.480 equilibrium in the goods market now we 00:11:22.519 --> 00:11:25.959 have an an interest rate which is 00:11:24.480 --> 00:11:27.720 consistent with equilibrium in financial 00:11:25.958 --> 00:11:30.799 markets that's what the central bank is 00:11:27.720 --> 00:11:32.560 there to ensure and so at that interest 00:11:30.799 --> 00:11:34.159 rate we can look into the yes what is 00:11:32.559 --> 00:11:36.479 the level of output that corresponds to 00:11:34.159 --> 00:11:37.559 that that's what we get here okay so now 00:11:36.480 --> 00:11:40.039 we 00:11:37.559 --> 00:11:41.638 found an equilibrium we found a 00:11:40.039 --> 00:11:44.199 combination of interest and output that 00:11:41.639 --> 00:11:47.200 is consistent with equilibrium in both 00:11:44.200 --> 00:11:49.519 Goods markets and financial markets okay 00:11:47.200 --> 00:11:52.120 and that's what the eslm model is about 00:11:49.519 --> 00:11:53.799 it's about finding those 00:11:52.120 --> 00:11:57.799 combinations 00:11:53.799 --> 00:11:57.799 okay good 00:12:00.078 --> 00:12:07.319 is this very clear yes 00:12:04.360 --> 00:12:10.120 yes okay 00:12:07.320 --> 00:12:11.879 good so now we can begin to play with 00:12:10.120 --> 00:12:14.198 this stuff we can one of the main 00:12:11.879 --> 00:12:18.078 purposes of the islm model is to 00:12:14.198 --> 00:12:20.000 understand policy macroeconomic policies 00:12:18.078 --> 00:12:22.198 what you what you should do in certain 00:12:20.000 --> 00:12:23.120 environments or not well before knowing 00:12:22.198 --> 00:12:25.278 what you should do in certain 00:12:23.120 --> 00:12:26.799 environments you need to understand what 00:12:25.278 --> 00:12:29.360 is that the different macroeconomic 00:12:26.799 --> 00:12:31.879 policies do to equilibrium output and 00:12:29.360 --> 00:12:33.440 interest rate and so on and so that's 00:12:31.879 --> 00:12:36.198 what we began to do and the first 00:12:33.440 --> 00:12:38.600 experiment was was one of fiscal 00:12:36.198 --> 00:12:40.559 policy so that's an example of a 00:12:38.600 --> 00:12:42.839 contractionary fiscal policy that could 00:12:40.559 --> 00:12:45.638 happen as a contractionary fiscal policy 00:12:42.839 --> 00:12:47.600 is essentially increasing taxes like 00:12:45.639 --> 00:12:49.360 like we Illustrated before or a 00:12:47.600 --> 00:12:53.079 reduction in government expenditure 00:12:49.360 --> 00:12:56.278 either of those H will lead to a shift 00:12:53.078 --> 00:12:59.559 in the yes to the left okay remember 00:12:56.278 --> 00:13:01.278 from lecture three if I increase taxes 00:12:59.559 --> 00:13:03.719 or reduce government expenditure 00:13:01.278 --> 00:13:07.879 equilibrium output will fall that's 00:13:03.720 --> 00:13:11.120 lecture three remember H and and and and 00:13:07.879 --> 00:13:12.838 so I can chase using lecture three I can 00:13:11.120 --> 00:13:16.720 I tell you well that yes will shift to 00:13:12.839 --> 00:13:18.480 the left no we just did that but now we 00:13:16.720 --> 00:13:20.120 know more because we know that the 00:13:18.480 --> 00:13:22.000 central bank is also pinning down the 00:13:20.120 --> 00:13:24.000 interest rate and in this particular 00:13:22.000 --> 00:13:26.480 example here the central bank did not go 00:13:24.000 --> 00:13:27.679 along with the treasury Department and 00:13:26.480 --> 00:13:29.240 say okay I'm going to keep the interest 00:13:27.679 --> 00:13:31.319 rate whatever it is you do whatever you 00:13:29.240 --> 00:13:34.680 one with 00:13:31.320 --> 00:13:37.399 the fiscal policy so this is an example 00:13:34.679 --> 00:13:40.159 of a situation where fiscal policy 00:13:37.399 --> 00:13:42.839 contractionary and the Central Bank 00:13:40.159 --> 00:13:45.240 remains H with its previous Target 00:13:42.839 --> 00:13:48.560 interest rate target okay so as a result 00:13:45.240 --> 00:13:50.959 of that a contractionary fiscal policy 00:13:48.559 --> 00:13:53.198 as the word says a then is a 00:13:50.958 --> 00:13:56.000 contractionary aggregate demand policy 00:13:53.198 --> 00:13:57.719 ends up also leading to lower 00:13:56.000 --> 00:14:01.519 equilibrium 00:13:57.720 --> 00:14:05.680 output and then I ask I already told you 00:14:01.519 --> 00:14:07.799 two things T up or G down but what else 00:14:05.679 --> 00:14:10.239 would do something similar to this which 00:14:07.799 --> 00:14:10.240 is not 00:14:22.919 --> 00:14:26.719 policy exactly I want anything that is a 00:14:25.360 --> 00:14:28.480 shock to aggregate demand different from 00:14:26.720 --> 00:14:31.120 interest rate or anything like that so 00:14:28.480 --> 00:14:33.680 for example consumer confidence that 00:14:31.120 --> 00:14:35.320 thing that we put in c0 or wealth 00:14:33.679 --> 00:14:37.879 something that wasn't in the mold but 00:14:35.320 --> 00:14:40.040 clearly is what is behind c0 that would 00:14:37.879 --> 00:14:42.639 lead to a shock like that and it's 00:14:40.039 --> 00:14:44.519 contraction that's the reason you know 00:14:42.639 --> 00:14:45.919 central banks and financial markets are 00:14:44.519 --> 00:14:47.600 all the time looking at sort of the 00:14:45.919 --> 00:14:49.240 releases of surveys of consumer 00:14:47.600 --> 00:14:52.879 confidence and things of that 00:14:49.240 --> 00:14:55.959 kind because these are the implications 00:14:52.879 --> 00:14:59.559 of of shocks to to to consumer 00:14:55.958 --> 00:15:01.719 confidence and so on okay good so 00:14:59.559 --> 00:15:03.599 what is a what is the mechanism here 00:15:01.720 --> 00:15:04.680 well you know it we have discussed it 00:15:03.600 --> 00:15:08.399 multiple 00:15:04.679 --> 00:15:10.159 times H the contraction in fiscal policy 00:15:08.399 --> 00:15:11.759 lowers the aggregate demand down then 00:15:10.159 --> 00:15:13.399 via multiplier you end up lowering 00:15:11.759 --> 00:15:15.560 output a lot 00:15:13.399 --> 00:15:16.879 more and this happens for a given 00:15:15.559 --> 00:15:21.000 interest rate I'm having the same 00:15:16.879 --> 00:15:23.000 interest rate here and there because I'm 00:15:21.000 --> 00:15:25.919 looking at at two points 00:15:23.000 --> 00:15:27.360 along for a fixed LM for a fixed 00:15:25.919 --> 00:15:30.360 interest 00:15:27.360 --> 00:15:31.879 rate good 00:15:30.360 --> 00:15:34.879 so that's a that's a contractionary 00:15:31.879 --> 00:15:38.399 monetary policy needless to say an 00:15:34.879 --> 00:15:40.600 expansionary fiscal policy sorry is just 00:15:38.399 --> 00:15:42.759 a shift in the opposite direction so 00:15:40.600 --> 00:15:45.680 what will an expansionary fiscal policy 00:15:42.759 --> 00:15:45.680 do to equilibrium 00:15:46.919 --> 00:15:51.318 output 00:15:48.720 --> 00:15:53.000 expansionary okay will increase output 00:15:51.318 --> 00:15:55.198 okay this was contraction fiscal policy 00:15:53.000 --> 00:15:56.839 reduce output we'll do the opposite 00:15:55.198 --> 00:15:58.439 obviously will increase output so that's 00:15:56.839 --> 00:16:01.120 expansion in fiscal policy and it's a 00:15:58.440 --> 00:16:03.560 very important tool to move output 00:16:01.120 --> 00:16:05.318 around when the econom is in a recession 00:16:03.559 --> 00:16:08.198 or so on so 00:16:05.318 --> 00:16:10.120 forth the other canonical macroeconomic 00:16:08.198 --> 00:16:12.799 policies monetary policy and that's an 00:16:10.120 --> 00:16:15.120 example of an expansionary monetary 00:16:12.799 --> 00:16:16.799 policy so an expansionary monetary 00:16:15.120 --> 00:16:20.278 policy Cuts interest 00:16:16.799 --> 00:16:22.278 rate why is that expansion well look it 00:16:20.278 --> 00:16:25.600 is expansion you 00:16:22.278 --> 00:16:26.919 know let me take this as I'm going to do 00:16:25.600 --> 00:16:30.399 things in a step 00:16:26.919 --> 00:16:32.198 so claim first an expansion in monetary 00:16:30.399 --> 00:16:34.078 policy is a reduction in the interest 00:16:32.198 --> 00:16:35.639 rate so the the central bank now decides 00:16:34.078 --> 00:16:39.599 to set a lower interest rate than it 00:16:35.639 --> 00:16:41.600 used to as a result of that no if output 00:16:39.600 --> 00:16:42.720 didn't change what would happen in the 00:16:41.600 --> 00:16:45.319 Goods 00:16:42.720 --> 00:16:47.800 Market so suppose that the FED cuts the 00:16:45.318 --> 00:16:49.919 interest rate and output doesn't 00:16:47.799 --> 00:16:52.198 change is that an equilibrium in the 00:16:49.919 --> 00:16:52.198 Goods 00:16:57.039 --> 00:17:01.759 Market is that an equili in the Goods 00:16:59.278 --> 00:17:04.038 Market suppose that the the the the FED 00:17:01.759 --> 00:17:05.720 cuts the interest rate and now I say 00:17:04.038 --> 00:17:07.558 okay well nothing will happen here 00:17:05.720 --> 00:17:09.759 output will stay where it is would have 00:17:07.558 --> 00:17:13.160 a lower interest rate that's 00:17:09.759 --> 00:17:17.119 nice wh why is that's not the final 00:17:13.160 --> 00:17:17.120 outcome of of the monetary policy 00:17:20.838 --> 00:17:25.240 expansion exactly this is an imbalance 00:17:23.160 --> 00:17:27.959 no because aggregate demand now a lower 00:17:25.240 --> 00:17:30.000 interest rate investment will go up this 00:17:27.959 --> 00:17:31.519 physical investment remember purchase of 00:17:30.000 --> 00:17:33.119 goods and services by firms for the 00:17:31.519 --> 00:17:37.519 purpose of building Capital structures 00:17:33.119 --> 00:17:39.038 and like that so a aggre demand went up 00:17:37.519 --> 00:17:40.519 so now we have a dise equilibrium there 00:17:39.038 --> 00:17:42.000 output is less than aggregate demand and 00:17:40.519 --> 00:17:44.200 we know that output is determined by 00:17:42.000 --> 00:17:46.400 aggre demand and then we go on through 00:17:44.200 --> 00:17:48.640 all the mechanism okay so this point is 00:17:46.400 --> 00:17:50.600 not an equilibrium we're going to end up 00:17:48.640 --> 00:17:52.280 with a higher level of output at that 00:17:50.599 --> 00:17:54.639 lower interest rate we have a lower 00:17:52.279 --> 00:17:56.399 level of output therefore it's not 00:17:54.640 --> 00:17:58.200 surprising that we call this an 00:17:56.400 --> 00:18:00.080 expansionary monetary policy so when the 00:17:58.200 --> 00:18:03.840 FED cuts the interest rate that's an 00:18:00.079 --> 00:18:06.079 expansionary monetary policy okay will 00:18:03.839 --> 00:18:09.000 expand aggregate 00:18:06.079 --> 00:18:12.199 demand good so how does the FED 00:18:09.000 --> 00:18:14.319 implement this sorry they can do 00:18:12.200 --> 00:18:17.840 expansionary open market operations yeah 00:18:14.319 --> 00:18:20.798 there you are perfect so what they they 00:18:17.839 --> 00:18:23.798 need to do is do some expansion in 00:18:20.798 --> 00:18:25.240 monetary open market operation no again 00:18:23.798 --> 00:18:28.319 now it's a little more sophisticated 00:18:25.240 --> 00:18:30.960 than that but but let's stick with this 00:18:28.319 --> 00:18:33.240 that is the first thing they'll do is 00:18:30.960 --> 00:18:35.120 they they'll shift money supply okay 00:18:33.240 --> 00:18:38.120 they go out there and start buying bonds 00:18:35.119 --> 00:18:39.798 and and and and giving money to 00:18:38.119 --> 00:18:41.319 injecting money into the system 00:18:39.798 --> 00:18:43.720 particularly through the 00:18:41.319 --> 00:18:45.439 banks so that's initial response that's 00:18:43.720 --> 00:18:49.000 what we'll cut the interest 00:18:45.440 --> 00:18:49.000 rate what happens 00:18:53.480 --> 00:18:58.000 next this this will allow me to 00:18:55.558 --> 00:19:01.200 illustrate sort of the modern I yes 00:18:58.000 --> 00:19:04.880 remember the f the fed's decision was 00:19:01.200 --> 00:19:06.600 not to increase the money supply by you 00:19:04.880 --> 00:19:09.120 know 00:19:06.599 --> 00:19:10.639 35% what the FED communicated to the 00:19:09.119 --> 00:19:12.839 market was that it was going to cut 00:19:10.640 --> 00:19:16.919 interest rate by 50 basis points that's 00:19:12.839 --> 00:19:19.240 the communication so initially the way 00:19:16.919 --> 00:19:22.440 it does that overnight is it goes out 00:19:19.240 --> 00:19:22.440 and does exactly 00:19:24.359 --> 00:19:29.479 that 00:19:26.798 --> 00:19:31.200 so what it did 00:19:29.480 --> 00:19:34.960 is what we have there no we had some 00:19:31.200 --> 00:19:34.960 interest rate I 00:19:36.798 --> 00:19:41.359 zero the FED now wanted to go to 00:19:43.400 --> 00:19:49.280 i1 okay so in order to do that well you 00:19:46.880 --> 00:19:52.880 have to look at this money 00:19:49.279 --> 00:19:54.960 demand and increase money supply to get 00:19:52.880 --> 00:19:56.640 to achieve the lower interest rate the 00:19:54.960 --> 00:20:00.000 question I'm asking you now does it a 00:19:56.640 --> 00:20:00.000 stop there 00:20:00.038 --> 00:20:04.558 so the the FED say okay I did my job you 00:20:02.440 --> 00:20:06.960 know I want to lower the interest rate 00:20:04.558 --> 00:20:08.599 I'm going to increase m i increase M and 00:20:06.960 --> 00:20:11.558 now I manag to bring the interest rate 00:20:08.599 --> 00:20:13.119 down to that point and that they 00:20:11.558 --> 00:20:14.359 intervene in overnight market so that 00:20:13.119 --> 00:20:17.158 happens very 00:20:14.359 --> 00:20:19.959 quickly do you think that the FED now 00:20:17.159 --> 00:20:19.960 can sleep for a 00:20:21.798 --> 00:20:26.000 while why not 00:20:30.960 --> 00:20:34.679 there are many reasons why the F cannot 00:20:32.759 --> 00:20:37.400 sleep for a long time but but but in 00:20:34.679 --> 00:20:37.400 this particular 00:20:41.279 --> 00:20:49.000 case okay yes money demand will 00:20:46.000 --> 00:20:49.000 increase 00:20:51.480 --> 00:20:56.480 why no so the first shock was an increas 00:20:55.319 --> 00:20:59.879 in money 00:20:56.480 --> 00:21:02.919 supply the point that I think you want 00:20:59.880 --> 00:21:05.760 to say is that because now the interest 00:21:02.919 --> 00:21:09.280 rate is lower equilibrium output will go 00:21:05.759 --> 00:21:11.919 up but if equilibrium go output goes up 00:21:09.279 --> 00:21:14.798 then what happens in this diagram well 00:21:11.919 --> 00:21:16.360 the money demand goes up because 00:21:14.798 --> 00:21:19.839 remember one of the parameters in this 00:21:16.359 --> 00:21:22.719 curve was output remember this was 00:21:19.839 --> 00:21:25.879 output times Li that's that that curve 00:21:22.720 --> 00:21:28.798 there when in this manone demand I had 00:21:25.880 --> 00:21:31.120 output fixed at y zero but now 00:21:28.798 --> 00:21:33.558 equilibrium output is higher so this 00:21:31.119 --> 00:21:38.519 Curve will also shift 00:21:33.558 --> 00:21:42.359 out okay now you're going to have y1 l i 00:21:38.519 --> 00:21:45.000 there so what what will the FED 00:21:42.359 --> 00:21:47.000 do see the FED doesn't do anything and 00:21:45.000 --> 00:21:49.359 it stops here then the interest rate 00:21:47.000 --> 00:21:51.880 goes back up not necessarily to the old 00:21:49.359 --> 00:21:54.278 level but will go up so what the FED 00:21:51.880 --> 00:21:57.400 will have to do is keep expanding 00:21:54.278 --> 00:21:59.240 money no sorry ugly diagram but it will 00:21:57.400 --> 00:22:01.159 keep expanding money 00:21:59.240 --> 00:22:03.599 up to so it can preserve the interest 00:22:01.159 --> 00:22:05.200 rate so that's you know in the old 00:22:03.599 --> 00:22:07.119 analysis you would have stopped in the 00:22:05.200 --> 00:22:09.319 first shot but nowadays that's not the 00:22:07.119 --> 00:22:11.199 FED says look I'm going to provide money 00:22:09.319 --> 00:22:13.079 and I know it takes time for output to 00:22:11.200 --> 00:22:15.278 expand and all that so I will 00:22:13.079 --> 00:22:17.278 accommodate all that comes it will not 00:22:15.278 --> 00:22:19.480 come overnight all this extra demand for 00:22:17.278 --> 00:22:21.839 money but I know there will be more 00:22:19.480 --> 00:22:25.480 demand coming along if I'm successful at 00:22:21.839 --> 00:22:28.639 expanding economic activity okay so the 00:22:25.480 --> 00:22:31.079 the Central Bank knows that if this ends 00:22:28.640 --> 00:22:34.000 up happening then that they will have to 00:22:31.079 --> 00:22:35.278 provide more money than than initially 00:22:34.000 --> 00:22:38.640 just to preserve the interest at the 00:22:35.278 --> 00:22:40.400 lower rate again we don't have any 00:22:38.640 --> 00:22:42.038 concept of time in this course and I 00:22:40.400 --> 00:22:42.919 don't think that well we'll do a little 00:22:42.038 --> 00:22:45.558 bit 00:22:42.919 --> 00:22:47.480 later but things happen in reality in 00:22:45.558 --> 00:22:49.798 the financial markets they happen very 00:22:47.480 --> 00:22:51.519 quickly and then they take time the real 00:22:49.798 --> 00:22:53.798 side is much slower I mean this 00:22:51.519 --> 00:22:56.759 expansion in output takes a couple of 00:22:53.798 --> 00:22:58.759 years for example it's slower the 00:22:56.759 --> 00:23:01.278 reaction of interest rate asset price 00:22:58.759 --> 00:23:03.798 and so on happens overnight instantly 00:23:01.278 --> 00:23:06.798 when people do analysis of the impact of 00:23:03.798 --> 00:23:09.839 monetary policy on on financial assets 00:23:06.798 --> 00:23:12.000 prices you look at the small Windows the 00:23:09.839 --> 00:23:13.158 minutes around an announcement or 00:23:12.000 --> 00:23:15.319 something like that to understand what 00:23:13.159 --> 00:23:18.480 is the impact when you look at the 00:23:15.319 --> 00:23:20.519 impact of monetary policies or prices on 00:23:18.480 --> 00:23:23.159 real activity you look over the span of 00:23:20.519 --> 00:23:25.960 quarters that's your unit of and and you 00:23:23.159 --> 00:23:28.679 begin to see effects a quarter later and 00:23:25.960 --> 00:23:31.120 you keep seeing effects you know eight 00:23:28.679 --> 00:23:32.480 quarters later so so different time 00:23:31.119 --> 00:23:35.558 scale in this course we're not worrying 00:23:32.480 --> 00:23:37.759 about that but but everything happens at 00:23:35.558 --> 00:23:39.960 once so so really what will happen in 00:23:37.759 --> 00:23:42.038 this course is that it won't be enough 00:23:39.960 --> 00:23:44.038 to increase money supply to this point 00:23:42.038 --> 00:23:46.319 in order to have an interest rate at the 00:23:44.038 --> 00:23:47.839 final equilibrium level of output at 00:23:46.319 --> 00:23:50.558 this level I'm going to have to expand 00:23:47.839 --> 00:23:55.079 money supply a lot more okay that's what 00:23:50.558 --> 00:23:55.079 I'm saying good 00:24:01.159 --> 00:24:06.200 so again I can always go back to my 00:24:04.079 --> 00:24:08.278 lecture three remember I always I told 00:24:06.200 --> 00:24:10.120 you that that diagram in lecture three 00:24:08.278 --> 00:24:12.119 was going to be very important the 00:24:10.119 --> 00:24:14.278 expansionary effects of an expansionary 00:24:12.119 --> 00:24:16.678 monetary policy can be analyzed in the 00:24:14.278 --> 00:24:19.079 lecture three diagram because there we 00:24:16.679 --> 00:24:20.960 take as given an interest rate and now 00:24:19.079 --> 00:24:22.918 we know that when I have a a higher 00:24:20.960 --> 00:24:24.880 interest rate a lower interest rate 00:24:22.919 --> 00:24:26.399 we'll bring this aggregate demand up and 00:24:24.880 --> 00:24:29.240 then we get them multiplied and blah 00:24:26.398 --> 00:24:31.079 blah blah blah blah okay that's that's 00:24:29.240 --> 00:24:34.000 what so 00:24:31.079 --> 00:24:36.398 this is a movement in the when when 00:24:34.000 --> 00:24:37.558 monetary policy changes that's another 00:24:36.398 --> 00:24:39.639 thing that is very important when you do 00:24:37.558 --> 00:24:41.678 islm analysis whenever you ask a 00:24:39.640 --> 00:24:43.840 question the first thing you need to 00:24:41.679 --> 00:24:46.240 think about is which curve is this 00:24:43.839 --> 00:24:50.278 policy moving or which curve is this 00:24:46.240 --> 00:24:53.079 shock moving okay and what I know is 00:24:50.278 --> 00:24:57.319 that monetary policy fiscal policy will 00:24:53.079 --> 00:24:59.759 always move the is will it move the 00:24:57.319 --> 00:25:01.639 LM no it has nothing to do with things 00:24:59.759 --> 00:25:03.519 that happen in financial Market that 00:25:01.640 --> 00:25:05.679 doesn't mean that the FED may not wish 00:25:03.519 --> 00:25:08.359 wish to respond to the fiscal expansion 00:25:05.679 --> 00:25:10.600 or whatever but but but but that's a 00:25:08.359 --> 00:25:12.678 response that the FED decize is not a 00:25:10.599 --> 00:25:15.398 direct consequence to the fiscal policy 00:25:12.679 --> 00:25:17.798 it's not fiscal policy not bandle with 00:25:15.398 --> 00:25:20.599 with interventions in the financial 00:25:17.798 --> 00:25:23.679 Market contrary to that is monetary 00:25:20.599 --> 00:25:26.278 policy I tell you the FED decides to cut 00:25:23.679 --> 00:25:29.000 interest rate that's a movement of the 00:25:26.278 --> 00:25:31.119 LM has nothing to do with the is 00:25:29.000 --> 00:25:33.480 so anything that happens in the is is 00:25:31.119 --> 00:25:36.639 going to be a movement along the is not 00:25:33.480 --> 00:25:39.720 a shift of the is so that's that's what 00:25:36.640 --> 00:25:41.159 we saw here no when when the FED cut 00:25:39.720 --> 00:25:42.960 interest rate we end up with higher 00:25:41.159 --> 00:25:44.799 output but that was a result of a shift 00:25:42.960 --> 00:25:47.720 along 00:25:44.798 --> 00:25:49.879 the because monetary policy is not an 00:25:47.720 --> 00:25:53.440 policy it's an LM 00:25:49.880 --> 00:25:56.039 policy fiscal policy is an as policy 00:25:53.440 --> 00:25:59.519 that is something that shift the is and 00:25:56.038 --> 00:26:03.440 not the LM so that is very important 00:25:59.519 --> 00:26:07.918 to to understand again what moves 00:26:03.440 --> 00:26:10.080 what okay so let's look at at the anyway 00:26:07.919 --> 00:26:11.840 so let me pause here because if you 00:26:10.079 --> 00:26:16.278 understand sort of what I just 00:26:11.839 --> 00:26:19.599 said it's two third of your quiz so so 00:26:16.278 --> 00:26:20.919 make sure that you understand it okay I 00:26:19.599 --> 00:26:22.119 mean if you really understand it 00:26:20.919 --> 00:26:24.679 obviously we're not going to ask you 00:26:22.119 --> 00:26:27.798 exactly this but there small 00:26:24.679 --> 00:26:29.798 perturbations around what I just said 00:26:27.798 --> 00:26:31.480 okay 00:26:29.798 --> 00:26:33.000 so now we can use this stuff even more 00:26:31.480 --> 00:26:35.480 now we understand what the basic 00:26:33.000 --> 00:26:39.398 monetary policy does we understand what 00:26:35.480 --> 00:26:42.720 basic fiscal policy does to the economy 00:26:39.398 --> 00:26:46.278 H let's look at some 00:26:42.720 --> 00:26:49.600 scenarios this I'm calling all in what 00:26:46.278 --> 00:26:49.599 what what am I representing 00:26:54.000 --> 00:26:58.480 there in that diagram 00:27:02.480 --> 00:27:06.480 so I'm saying all that you see in that 00:27:04.440 --> 00:27:09.519 diagram is a result of policy decision 00:27:06.480 --> 00:27:09.519 macroeconomic policy 00:27:10.200 --> 00:27:14.519 decision exactly that's the reason I'm 00:27:12.558 --> 00:27:16.720 calling it all in you know that's a case 00:27:14.519 --> 00:27:19.679 in which both want to be very 00:27:16.720 --> 00:27:21.558 expansionary okay and so you see that 00:27:19.679 --> 00:27:23.440 the mon the expansionary monetary policy 00:27:21.558 --> 00:27:25.240 already sort of increase equilibrium 00:27:23.440 --> 00:27:26.919 output but then you add to it 00:27:25.240 --> 00:27:28.599 expansionary fiscal policy which moves 00:27:26.919 --> 00:27:30.278 theas to the right and you further 00:27:28.599 --> 00:27:32.599 increase 00:27:30.278 --> 00:27:35.119 output okay so you end up with a big 00:27:32.599 --> 00:27:38.158 increase in output as a result of this 00:27:35.119 --> 00:27:43.079 powerful policy package when do you 00:27:38.159 --> 00:27:43.080 think you may see situations like 00:27:47.398 --> 00:27:53.959 that sometimes you see it out of pure 00:27:51.159 --> 00:27:55.600 responsibility I mean yes people go to 00:27:53.960 --> 00:27:59.278 Argentina this happens all the time for 00:27:55.599 --> 00:28:01.678 the wrong reasons but but if if if if H 00:27:59.278 --> 00:28:03.839 in normal times normal environments when 00:28:01.679 --> 00:28:05.880 do you think that I should have said 00:28:03.839 --> 00:28:08.319 normal times in normal 00:28:05.880 --> 00:28:10.200 environments sort of with sound 00:28:08.319 --> 00:28:13.839 macroeconomic policy when do you think 00:28:10.200 --> 00:28:13.840 you would see something like 00:28:15.240 --> 00:28:20.440 this recessions you know and the biggest 00:28:18.558 --> 00:28:22.798 during recessions you you need to get 00:28:20.440 --> 00:28:25.360 the economy out of the of the whole and 00:28:22.798 --> 00:28:26.960 then you you'll probably you'll first 00:28:25.359 --> 00:28:28.918 try monetary policy because that's the 00:28:26.960 --> 00:28:30.480 most direct and quick I mean that's a 00:28:28.919 --> 00:28:33.360 decision that can be made 00:28:30.480 --> 00:28:36.278 overnight no but often when the rec is 00:28:33.359 --> 00:28:38.639 officially deep that's not enough and 00:28:36.278 --> 00:28:40.359 you need more and that's what you do 00:28:38.640 --> 00:28:41.679 with fiscal policy there other reasons 00:28:40.359 --> 00:28:43.839 there are differen between the two 00:28:41.679 --> 00:28:46.840 policies because we're not looking under 00:28:43.839 --> 00:28:48.839 the hood here but for example in Co it 00:28:46.839 --> 00:28:50.199 was very certain group of people were 00:28:48.839 --> 00:28:51.558 much more affected than others I mean 00:28:50.200 --> 00:28:52.880 people that work in restaurants those 00:28:51.558 --> 00:28:55.200 guys just lost their job there was 00:28:52.880 --> 00:28:57.600 nothing they could do so there was a 00:28:55.200 --> 00:29:00.919 reason to Target the transfers when you 00:28:57.599 --> 00:29:03.439 use rate is very Bland policy to 00:29:00.919 --> 00:29:05.399 everyone when when you use a fiscal 00:29:03.440 --> 00:29:07.440 policy you can also it's not only the 00:29:05.398 --> 00:29:09.278 amount you spend but you can also Target 00:29:07.440 --> 00:29:11.919 the expenditure in certain directions 00:29:09.278 --> 00:29:14.240 and and so there other reasons why you 00:29:11.919 --> 00:29:16.799 may want to use the two tools but the 00:29:14.240 --> 00:29:18.640 main one is the first ordered one is if 00:29:16.798 --> 00:29:20.359 you're in a deep recession you need 00:29:18.640 --> 00:29:22.519 everything to try to lift the economy 00:29:20.359 --> 00:29:25.918 out of that and so that's the kind of 00:29:22.519 --> 00:29:29.000 packages you see in big 00:29:25.919 --> 00:29:32.000 recessions now 00:29:29.000 --> 00:29:33.919 there's a there's a slide that I that I 00:29:32.000 --> 00:29:35.960 think I have pending from from two 00:29:33.919 --> 00:29:38.240 lectures ago and and this is a good 00:29:35.960 --> 00:29:40.200 opportunity to to bring it back remember 00:29:38.240 --> 00:29:43.759 when we look at equilibrium in financial 00:29:40.200 --> 00:29:46.759 markets we we came up with this H 00:29:43.759 --> 00:29:48.158 downward sloping demand money demand 00:29:46.759 --> 00:29:50.038 then we said well you lower the interest 00:29:48.159 --> 00:29:52.360 rate there's more more money demand and 00:29:50.038 --> 00:29:54.200 so on so forth and we said therefore the 00:29:52.359 --> 00:29:56.158 way the FED lowers interest rate or the 00:29:54.200 --> 00:29:58.720 Central Bank lowers the interest rate is 00:29:56.159 --> 00:30:00.600 by increasing money supply 00:29:58.720 --> 00:30:02.038 the point of this picture is that 00:30:00.599 --> 00:30:03.879 there's a limit to 00:30:02.038 --> 00:30:07.119 that and the 00:30:03.880 --> 00:30:08.360 limit is more or less when the interest 00:30:07.119 --> 00:30:10.518 rate reaches 00:30:08.359 --> 00:30:12.278 zero because when the interest rate 00:30:10.519 --> 00:30:13.200 reaches the nominal interest rate 00:30:12.278 --> 00:30:16.240 reaches 00:30:13.200 --> 00:30:19.519 zero then there's no cost in holding 00:30:16.240 --> 00:30:21.599 bonds remember the the in holding money 00:30:19.519 --> 00:30:23.120 sorry the only reason for you not to 00:30:21.599 --> 00:30:24.918 hold all your wealth in the form of 00:30:23.119 --> 00:30:28.319 money because you were giving up some 00:30:24.919 --> 00:30:30.240 opportunity cost of investing in bonds 00:30:28.319 --> 00:30:32.079 which were inconvenient Financial assets 00:30:30.240 --> 00:30:33.399 because you couldn't transact with them 00:30:32.079 --> 00:30:35.678 but they pay you higher interest that's 00:30:33.398 --> 00:30:37.359 the reason you want to go there but once 00:30:35.679 --> 00:30:39.600 you reach zero interest rate then you're 00:30:37.359 --> 00:30:40.959 indifferent and you might as well hold 00:30:39.599 --> 00:30:43.199 if the Central Bank goes out there and 00:30:40.960 --> 00:30:44.720 doesn't man open market operation you 00:30:43.200 --> 00:30:46.640 don't need to be compensated for that 00:30:44.720 --> 00:30:49.159 because you you're totally willing to 00:30:46.640 --> 00:30:51.200 hold your wealth in the form of money 00:30:49.159 --> 00:30:54.039 and so monetary policy is no longer 00:30:51.200 --> 00:30:56.480 effective when you when you reach the 00:30:54.038 --> 00:30:59.558 what is called the zero lower bound and 00:30:56.480 --> 00:31:01.919 that's what we call the liquidity TR 00:30:59.558 --> 00:31:04.798 okay it's called the liquidity trap let 00:31:01.919 --> 00:31:07.000 me not get into why but but essentially 00:31:04.798 --> 00:31:08.319 is is that is said you can inject more 00:31:07.000 --> 00:31:10.720 and more liquidity but you cannot move 00:31:08.319 --> 00:31:13.278 the interest rate so you lost a policy 00:31:10.720 --> 00:31:16.000 tool this was the tragedy of Japan for 00:31:13.278 --> 00:31:18.679 many decades okay they they they were 00:31:16.000 --> 00:31:20.798 stuck against the zero lower bound the 00:31:18.679 --> 00:31:23.360 liquidity trap and so they had to go 00:31:20.798 --> 00:31:24.839 through massive fiscal expansions 00:31:23.359 --> 00:31:26.879 because they didn't have they were in 00:31:24.839 --> 00:31:29.000 recession chronic recessions and they 00:31:26.880 --> 00:31:31.000 didn't have powerful monetary policy 00:31:29.000 --> 00:31:34.200 tool because they were against the zero 00:31:31.000 --> 00:31:36.919 lower B so why did I use this 00:31:34.200 --> 00:31:39.159 opportunity to bring this about because 00:31:36.919 --> 00:31:41.880 that's for the reason I just described 00:31:39.159 --> 00:31:44.039 the case of Japan but 00:31:41.880 --> 00:31:46.000 but I asked the question here what would 00:31:44.038 --> 00:31:47.679 you advise the government to do when I 00:31:46.000 --> 00:31:50.558 already told you the answer if if you 00:31:47.679 --> 00:31:52.840 have an economy is and a recession and 00:31:50.558 --> 00:31:55.798 and this means you use all the monetary 00:31:52.839 --> 00:31:57.359 policy that you had conventional mon 00:31:55.798 --> 00:31:59.359 monetary policy that you have now we 00:31:57.359 --> 00:32:00.638 have UNC conventional monetary but I'll 00:31:59.359 --> 00:32:04.199 tell you a little bit more about that 00:32:00.638 --> 00:32:05.519 later but once you run out of this and 00:32:04.200 --> 00:32:08.480 you're still in a recession what would 00:32:05.519 --> 00:32:08.480 you tell the government to 00:32:10.720 --> 00:32:15.038 do use fiscal policy that's the other 00:32:13.319 --> 00:32:17.558 tool you are so that's a typical 00:32:15.038 --> 00:32:19.519 situation you see when countries are the 00:32:17.558 --> 00:32:21.398 interest rate are already very low they 00:32:19.519 --> 00:32:22.919 tend to use much more actively fiscal 00:32:21.398 --> 00:32:24.719 policy because it's the only policy they 00:32:22.919 --> 00:32:27.440 have left and that has been the case of 00:32:24.720 --> 00:32:32.038 Japan again since the crash of their 00:32:27.440 --> 00:32:36.120 financial bubble in the late 80s early 00:32:32.038 --> 00:32:38.480 90s so look at the covid-19 response 00:32:36.119 --> 00:32:41.719 something happened to my figure here but 00:32:38.480 --> 00:32:42.880 anyways this is zero essentially so this 00:32:41.720 --> 00:32:46.200 is 00:32:42.880 --> 00:32:48.440 covid okay the covid shock happened 00:32:46.200 --> 00:32:51.000 clearly the economy was imploding into 00:32:48.440 --> 00:32:53.519 recession the FED immediately reacted 00:32:51.000 --> 00:32:56.200 and cut interest very very aggressively 00:32:53.519 --> 00:32:57.519 to zero and then we were stack there 00:32:56.200 --> 00:33:00.080 this is effectively zero I mean they're 00:32:57.519 --> 00:33:02.079 Technic things why thing moves a little 00:33:00.079 --> 00:33:05.240 but but this is effectively 00:33:02.079 --> 00:33:08.638 zero so the US was during that period 00:33:05.240 --> 00:33:10.519 against really a a a liquidity against 00:33:08.638 --> 00:33:13.079 the zero lower bound there was no more 00:33:10.519 --> 00:33:15.240 power for the kind of monetary policy 00:33:13.079 --> 00:33:17.798 that we have describe 00:33:15.240 --> 00:33:20.720 here so let 00:33:17.798 --> 00:33:22.000 me so so that tells you that that 00:33:20.720 --> 00:33:23.639 there's going to have to be a lots of 00:33:22.000 --> 00:33:25.159 fiscal policy if you want to get out of 00:33:23.638 --> 00:33:28.398 that and I'll show you that later there 00:33:25.159 --> 00:33:29.840 was a lot of fiscal policy but but 00:33:28.398 --> 00:33:31.079 before getting there I'm going to show 00:33:29.839 --> 00:33:33.319 you something that you don't need to 00:33:31.079 --> 00:33:36.359 really know for the quiz But but so you 00:33:33.319 --> 00:33:39.879 can understand what is going on the 00:33:36.359 --> 00:33:41.798 newspapers a little better the FED that 00:33:39.880 --> 00:33:43.519 was not the only precisely because 00:33:41.798 --> 00:33:46.879 because the situation of 00:33:43.519 --> 00:33:49.120 Japan was so chronic people began to 00:33:46.880 --> 00:33:51.840 develop lots of tools alternative tools 00:33:49.119 --> 00:33:53.518 for central banks to use when you your 00:33:51.839 --> 00:33:55.798 interest rate this the main interest 00:33:53.519 --> 00:33:57.880 rate you use is stuck against zero 00:33:55.798 --> 00:33:59.119 against the zero lower bound and that's 00:33:57.880 --> 00:34:01.720 what you may have heard is called 00:33:59.119 --> 00:34:04.479 sometimes unconventional monetary policy 00:34:01.720 --> 00:34:06.600 QE quantitative easing all those kind of 00:34:04.480 --> 00:34:09.559 things they represent essentially 00:34:06.599 --> 00:34:11.480 policies that are like monetary policy 00:34:09.559 --> 00:34:12.398 but they're not exactly the way we have 00:34:11.480 --> 00:34:14.119 because they don't they're not 00:34:12.398 --> 00:34:16.358 interventions in very shortterm bonds 00:34:14.119 --> 00:34:18.200 there interventions in other assets out 00:34:16.358 --> 00:34:20.719 there in this course we have it very 00:34:18.199 --> 00:34:22.398 simple we have only one interest rate in 00:34:20.719 --> 00:34:24.279 reality there are multiple bonds they 00:34:22.398 --> 00:34:25.838 are risky bonds they are spread somebody 00:34:24.280 --> 00:34:27.480 asked about risky Bonds in a few 00:34:25.838 --> 00:34:28.838 lectures ago there are Express there 00:34:27.480 --> 00:34:31.079 lots of of interest rates floating 00:34:28.838 --> 00:34:32.559 around so in principle a central bank 00:34:31.079 --> 00:34:34.639 could intervene in those other rates as 00:34:32.559 --> 00:34:36.719 well in fact in Japan they have even 00:34:34.639 --> 00:34:39.519 intervened in the stock market that 00:34:36.719 --> 00:34:41.398 tells you how far they can go okay so 00:34:39.519 --> 00:34:43.918 you so in a richer environment with more 00:34:41.398 --> 00:34:45.918 financial Assets in principle the FED 00:34:43.918 --> 00:34:47.799 could go beyond the standard short-term 00:34:45.918 --> 00:34:50.358 bonds that they go for for their open 00:34:47.800 --> 00:34:52.800 market operation and that's 00:34:50.358 --> 00:34:54.519 exactly what they have been doing a way 00:34:52.800 --> 00:34:56.679 of thinking about that is remember when 00:34:54.519 --> 00:34:59.079 when we look at a Monet expansion 00:34:56.679 --> 00:35:00.680 conventional monetary policy we start 00:34:59.079 --> 00:35:02.920 with a balance sheet like that remember 00:35:00.679 --> 00:35:04.838 we said the the central bank has bonds 00:35:02.920 --> 00:35:06.639 and then money if he wants to have an 00:35:04.838 --> 00:35:09.679 expansion in monetary policy goes out 00:35:06.639 --> 00:35:13.480 there it buys more bonds and gives them 00:35:09.679 --> 00:35:15.598 the gives the banks money okay and that 00:35:13.480 --> 00:35:16.838 expands the balance sheet you end up 00:35:15.599 --> 00:35:19.760 with more the balance sheet of the 00:35:16.838 --> 00:35:21.320 Central Bank ends up with more bonds and 00:35:19.760 --> 00:35:23.640 also with more liabilities because it 00:35:21.320 --> 00:35:27.800 gave more money to people out Banks and 00:35:23.639 --> 00:35:29.400 so on so he owes more money so monetary 00:35:27.800 --> 00:35:31.519 policy naturally expansion and monetary 00:35:29.400 --> 00:35:33.760 policy naturally leads to an expansion 00:35:31.519 --> 00:35:36.519 of the balance sheet now for 00:35:33.760 --> 00:35:39.040 years outside of Japan nobody really 00:35:36.519 --> 00:35:40.358 cared too much about that because this 00:35:39.039 --> 00:35:42.400 effect relative to what you saw in the 00:35:40.358 --> 00:35:43.838 interet was very small I mean yeah the 00:35:42.400 --> 00:35:47.320 balance sheet was moving a little bit 00:35:43.838 --> 00:35:48.440 but it was mild no so here we hit the 00:35:47.320 --> 00:35:50.760 zero lower 00:35:48.440 --> 00:35:53.679 bound and essentially the FED went out 00:35:50.760 --> 00:35:56.839 and bought all sort of things first of 00:35:53.679 --> 00:35:58.239 all the when you hear QE quantitative 00:35:56.838 --> 00:36:00.960 easing 00:35:58.239 --> 00:36:04.159 that means mostly that the FED goes out 00:36:00.960 --> 00:36:07.920 there and buys not only shortterm US 00:36:04.159 --> 00:36:09.279 Treasury bonds but long-term BS okay 00:36:07.920 --> 00:36:10.760 because there something called the term 00:36:09.280 --> 00:36:13.519 spread typically interest rates in the 00:36:10.760 --> 00:36:16.400 long run are higher than than interest 00:36:13.519 --> 00:36:18.358 rate in the short right typically 00:36:16.400 --> 00:36:21.160 controlling for a bunch of things and 00:36:18.358 --> 00:36:23.239 that's called the term premium well they 00:36:21.159 --> 00:36:25.759 went and bought those kind of bones they 00:36:23.239 --> 00:36:29.039 also bought bought bones issued by 00:36:25.760 --> 00:36:34.119 frenan f 00:36:29.039 --> 00:36:35.838 what is Freddy ma no Freddy and Fanny H 00:36:34.119 --> 00:36:38.079 mortgage back Securities a bunch of 00:36:35.838 --> 00:36:40.679 stuff even loans in fact they created a 00:36:38.079 --> 00:36:42.720 facility to buy corporate 00:36:40.679 --> 00:36:45.679 bonds and at some point they created a 00:36:42.719 --> 00:36:47.598 facility to buy Fallen Angels Bond 00:36:45.679 --> 00:36:49.159 initially it was only investment great 00:36:47.599 --> 00:36:51.480 bonds all the companies that have the 00:36:49.159 --> 00:36:53.960 best possible rating but that wasn't 00:36:51.480 --> 00:36:57.119 enough so they went out there and and 00:36:53.960 --> 00:36:59.119 created a facility to buy Fallen angin B 00:36:57.119 --> 00:37:02.440 Fallen were essentially companies that 00:36:59.119 --> 00:37:04.039 were Prime companies before covid but 00:37:02.440 --> 00:37:07.119 you know but after covid they didn't 00:37:04.039 --> 00:37:10.679 look so good Airlines you know cruises 00:37:07.119 --> 00:37:12.039 and stuff like that hotels and so on so 00:37:10.679 --> 00:37:14.559 that was a massive expansion of the 00:37:12.039 --> 00:37:18.719 balance sheet so in terms of this this 00:37:14.559 --> 00:37:20.318 guy grew a lot okay but the purpose 00:37:18.719 --> 00:37:21.679 that's like monetary policy that's what 00:37:20.318 --> 00:37:23.119 we call unconvention it's different from 00:37:21.679 --> 00:37:26.358 the standard one but they were doing 00:37:23.119 --> 00:37:28.318 trying to operate very much like 00:37:26.358 --> 00:37:31.239 monetary policy operates here you see 00:37:28.318 --> 00:37:33.400 the balance sheet of the fed you see 00:37:31.239 --> 00:37:36.959 before the the the global financial 00:37:33.400 --> 00:37:38.559 crisis or the Great Recession of 2008 00:37:36.960 --> 00:37:40.639 2009 00:37:38.559 --> 00:37:42.400 ER the balance sheet wasn't an 00:37:40.639 --> 00:37:43.838 interesting thing to look at as the 00:37:42.400 --> 00:37:46.880 central bank because the idea they did 00:37:43.838 --> 00:37:49.199 the regular open market operations and 00:37:46.880 --> 00:37:51.240 you know for for anti-al policy but you 00:37:49.199 --> 00:37:52.480 would see small Wiggles in the size of 00:37:51.239 --> 00:37:54.399 the balance sheet relative to the size 00:37:52.480 --> 00:37:56.000 of the balance sheet in the global 00:37:54.400 --> 00:37:59.039 financial crisis they hit the zero lower 00:37:56.000 --> 00:38:02.039 Bound for the first time the US and so 00:37:59.039 --> 00:38:03.960 there you saw massive expansion of the 00:38:02.039 --> 00:38:05.639 bance this is the number of assets the 00:38:03.960 --> 00:38:07.240 same happen to liabilities they out side 00:38:05.639 --> 00:38:10.879 of it is they're injecting massive 00:38:07.239 --> 00:38:13.479 amount of money into the economy okay so 00:38:10.880 --> 00:38:15.838 there use a big expansion the recovery 00:38:13.480 --> 00:38:18.159 from the global fin was hard because the 00:38:15.838 --> 00:38:20.119 financial sector was very compromised so 00:38:18.159 --> 00:38:21.598 it took them a while they kept doing 00:38:20.119 --> 00:38:24.720 these kind of policies then they began 00:38:21.599 --> 00:38:26.359 to unwind the balance sheet and then Co 00:38:24.719 --> 00:38:29.000 came and that's what I was showing you 00:38:26.358 --> 00:38:29.880 before massive they send the interest 00:38:29.000 --> 00:38:32.559 rate to 00:38:29.880 --> 00:38:34.720 zero that wasn't enough and then they 00:38:32.559 --> 00:38:37.559 went out and bought lots of other 00:38:34.719 --> 00:38:40.279 Financial assets which work very much 00:38:37.559 --> 00:38:42.000 like monetary policy big thing and now 00:38:40.280 --> 00:38:43.280 they're unwinding the thing now we're 00:38:42.000 --> 00:38:44.719 we're in the opposite process we have 00:38:43.280 --> 00:38:46.880 inflation we want to get out of this 00:38:44.719 --> 00:38:48.879 situation they unwinding but you can see 00:38:46.880 --> 00:38:50.760 the size of that is 00:38:48.880 --> 00:38:54.119 huge 00:38:50.760 --> 00:38:56.520 huge I mean this is you know the balance 00:38:54.119 --> 00:38:58.039 sheet that a couple of decades ago had 00:38:56.519 --> 00:38:59.880 was was when the of the order $1 00:38:58.039 --> 00:39:02.960 trillion which is more or less the money 00:38:59.880 --> 00:39:05.920 that is circulating around ER now it's 00:39:02.960 --> 00:39:08.240 $9 trillion massive 00:39:05.920 --> 00:39:09.800 theion and all central banks major 00:39:08.239 --> 00:39:12.479 central banks look like this I mean the 00:39:09.800 --> 00:39:14.519 ACB also looks like 00:39:12.480 --> 00:39:17.240 this the bank of 00:39:14.519 --> 00:39:18.759 Japan H looks like this but actually you 00:39:17.239 --> 00:39:21.519 don't see this blips that much because 00:39:18.760 --> 00:39:23.359 they began to do them here okay so they 00:39:21.519 --> 00:39:25.880 have been accumulating for a long 00:39:23.358 --> 00:39:28.318 time they have been using this kind of 00:39:25.880 --> 00:39:30.720 policy what about 00:39:28.318 --> 00:39:33.279 so coming back now to the course what 00:39:30.719 --> 00:39:34.838 about fiscal policy well I'm showing you 00:39:33.280 --> 00:39:37.119 different countries around the world 00:39:34.838 --> 00:39:40.559 massive fix fiscal expansion during the 00:39:37.119 --> 00:39:42.800 covid episode massive I mean this is you 00:39:40.559 --> 00:39:44.639 know the US the fiscal expansion if you 00:39:42.800 --> 00:39:46.039 combine all the packages so the order of 00:39:44.639 --> 00:39:49.039 20% of 00:39:46.039 --> 00:39:51.039 GDP that's huge for fiscal you don't see 00:39:49.039 --> 00:39:53.920 things like this and this happen almost 00:39:51.039 --> 00:39:56.838 everywhere okay now you don't see things 00:39:53.920 --> 00:39:59.240 like that outside of Wars this was 00:39:56.838 --> 00:40:01.519 really like a war there's no doubt of 00:39:59.239 --> 00:40:03.879 that the kind amount of expansion in 00:40:01.519 --> 00:40:06.480 fiscal policy we saw was comparable to 00:40:03.880 --> 00:40:06.480 what you see in a 00:40:06.800 --> 00:40:12.880 war so there you have it big recession 00:40:10.119 --> 00:40:15.760 huge recession massive policy response 00:40:12.880 --> 00:40:19.440 both monetary of a conventional and 00:40:15.760 --> 00:40:21.079 unconventional kind and fiscal and again 00:40:19.440 --> 00:40:23.800 this was not unique to the US it 00:40:21.079 --> 00:40:26.079 happened essentially everywhere China is 00:40:23.800 --> 00:40:29.680 a little different for reasons I think I 00:40:26.079 --> 00:40:32.560 mentioned uh in the first lecture 00:40:29.679 --> 00:40:34.199 but I may talk more about that 00:40:32.559 --> 00:40:37.880 later 00:40:34.199 --> 00:40:39.960 good okay so another policy mix this is 00:40:37.880 --> 00:40:42.519 different so what do we have 00:40:39.960 --> 00:40:45.280 there that's another policy mix that we 00:40:42.519 --> 00:40:47.400 see fairly 00:40:45.280 --> 00:40:50.319 frequently so what is 00:40:47.400 --> 00:40:51.400 that LM going down that's expansion in 00:40:50.318 --> 00:40:54.239 monetary 00:40:51.400 --> 00:40:57.800 policy I going to the left that's 00:40:54.239 --> 00:41:01.159 contractionary fiscal policy okay so 00:40:57.800 --> 00:41:01.160 when do you think you would do such a 00:41:03.280 --> 00:41:07.440 thing or countries would engage and 00:41:05.800 --> 00:41:09.200 things like this again what if you want 00:41:07.440 --> 00:41:11.800 to like reduce like government spending 00:41:09.199 --> 00:41:15.039 you want to off a recession exactly 00:41:11.800 --> 00:41:17.280 that's that's exactly the the conditions 00:41:15.039 --> 00:41:19.239 when you want to do this it's called 00:41:17.280 --> 00:41:20.440 consolidation of the fiscal deficit 00:41:19.239 --> 00:41:23.078 sometimes you you you know you have a 00:41:20.440 --> 00:41:24.960 large fiscal deficit that's leading to 00:41:23.079 --> 00:41:30.359 accumulation of public debt that doesn't 00:41:24.960 --> 00:41:32.760 look so good so the the the government 00:41:30.358 --> 00:41:37.239 the central the treasur in the case of 00:41:32.760 --> 00:41:40.200 the US may may decide that he wants to 00:41:37.239 --> 00:41:42.279 reduce fiscal policy but he's afraid 00:41:40.199 --> 00:41:44.279 because and doing so is going to cause a 00:41:42.280 --> 00:41:46.359 recession and the purpose and there is 00:41:44.280 --> 00:41:47.839 no problem of output being overheating 00:41:46.358 --> 00:41:50.519 that it's just that the fiscal accounts 00:41:47.838 --> 00:41:54.759 look look they 00:41:50.519 --> 00:41:56.239 weak so if that's a situation that is if 00:41:54.760 --> 00:41:57.560 the economy is not going is not going 00:41:56.239 --> 00:42:01.239 through an overheating period perod and 00:41:57.559 --> 00:42:03.400 so on and you want to reduce the fiscal 00:42:01.239 --> 00:42:06.000 deficit in some places it will be 00:42:03.400 --> 00:42:07.599 explicit in some places implicit but you 00:42:06.000 --> 00:42:10.800 know the central because the central 00:42:07.599 --> 00:42:13.680 bank has a goal to keep prices stable 00:42:10.800 --> 00:42:16.519 and an output close to the potential 00:42:13.679 --> 00:42:18.679 output so even if there's no explicit 00:42:16.519 --> 00:42:21.039 coordination if the if the government 00:42:18.679 --> 00:42:23.399 announce a massive fiscal consolation 00:42:21.039 --> 00:42:26.000 package say reduce going expenditure by 00:42:23.400 --> 00:42:28.000 10% the Central Bank knows that that's 00:42:26.000 --> 00:42:30.119 going to cause a recession and so the 00:42:28.000 --> 00:42:32.079 Central Bank naturally will respond by 00:42:30.119 --> 00:42:35.559 cutting interest rate to that because 00:42:32.079 --> 00:42:38.160 the recession is not needed if if the if 00:42:35.559 --> 00:42:40.160 the US announced today a a fiscal 00:42:38.159 --> 00:42:42.879 contraction of 5% I'm not sure the FED 00:42:40.159 --> 00:42:46.118 would do anything just stay there put 00:42:42.880 --> 00:42:48.559 okay because we have an economy is 00:42:46.119 --> 00:42:50.760 overheating but but so that's what you 00:42:48.559 --> 00:42:53.000 would do in a situation in which you 00:42:50.760 --> 00:42:55.319 want to fix the fiscal account and the 00:42:53.000 --> 00:42:59.119 economy is more or less at the at the 00:42:55.318 --> 00:42:59.119 normal time it's not it's not over here 00:43:00.519 --> 00:43:04.318 heating when would you do the 00:43:08.159 --> 00:43:13.960 opposite or when it's not when would you 00:43:11.800 --> 00:43:16.519 do the opposite is when are you likely 00:43:13.960 --> 00:43:16.519 to see the 00:43:19.519 --> 00:43:24.759 opposite so first of all what is the 00:43:21.719 --> 00:43:29.118 opposite the opposite is a combination 00:43:24.760 --> 00:43:29.119 of a fiscal expansion with a Monet 00:43:29.679 --> 00:43:34.879 contraction okay when do you think you 00:43:32.159 --> 00:43:34.879 would see such a 00:43:37.039 --> 00:43:44.199 thing either maybe when government has a 00:43:42.199 --> 00:43:47.598 budging maybe 00:43:44.199 --> 00:43:50.000 when rates are too 00:43:47.599 --> 00:43:53.519 high 00:43:50.000 --> 00:43:56.920 yeah okay that's 00:43:53.519 --> 00:43:58.759 true but but I'm not sure that's yeah 00:43:56.920 --> 00:44:02.400 but that requires a to concerted 00:43:58.760 --> 00:44:04.040 decision and so on H it's true yeah 00:44:02.400 --> 00:44:06.880 valid question it's not the one I wanted 00:44:04.039 --> 00:44:09.960 I wanted something more interesting but 00:44:06.880 --> 00:44:13.400 more exciting but but those 00:44:09.960 --> 00:44:13.400 are valid 00:44:15.719 --> 00:44:20.759 answers War you know War typically is 00:44:18.480 --> 00:44:20.760 all 00:44:23.280 --> 00:44:30.519 in no okay let me not I know it's a 00:44:28.000 --> 00:44:34.079 strange question but but I know where 00:44:30.519 --> 00:44:36.280 I'm heading a um suppose that the 00:44:34.079 --> 00:44:38.480 government decides to 00:44:36.280 --> 00:44:40.920 spend for whatever 00:44:38.480 --> 00:44:43.599 reason and the Central Bank says Whoa We 00:44:40.920 --> 00:44:45.680 don't need that expenditure now so you 00:44:43.599 --> 00:44:47.039 know we don't need this exp fiscal 00:44:45.679 --> 00:44:49.159 expansion now because we're on the 00:44:47.039 --> 00:44:51.639 margin of overheating and now I'm going 00:44:49.159 --> 00:44:53.838 to get this big fiscal expansion then 00:44:51.639 --> 00:44:56.719 the fed the central bank is likely to 00:44:53.838 --> 00:44:58.519 react to that and high interest rate 00:44:56.719 --> 00:45:00.799 that will will make very upset the 00:44:58.519 --> 00:45:02.599 government it always happens the 00:45:00.800 --> 00:45:03.880 government gets very upset guy say look 00:45:02.599 --> 00:45:06.640 I'm trying to span the economy and 00:45:03.880 --> 00:45:08.079 you're fighting me okay but that's the 00:45:06.639 --> 00:45:10.400 nature of the that's the reason central 00:45:08.079 --> 00:45:13.000 banks are meant to be independent so 00:45:10.400 --> 00:45:14.720 they can they can offset that and the 00:45:13.000 --> 00:45:16.318 reason I wanted to highlight the example 00:45:14.719 --> 00:45:17.519 is I think some of that and somebody 00:45:16.318 --> 00:45:21.279 asked that question I think in the 00:45:17.519 --> 00:45:23.960 previous lecture ER happened to the US 00:45:21.280 --> 00:45:26.440 economy one of the reasons we are in an 00:45:23.960 --> 00:45:28.199 overheating situation right now is 00:45:26.440 --> 00:45:30.519 because the US had a big fiscal 00:45:28.199 --> 00:45:32.838 expansion early in 00:45:30.519 --> 00:45:34.559 2021 and that fiscal expansion was at 00:45:32.838 --> 00:45:36.239 the time in which there wasn't much 00:45:34.559 --> 00:45:38.280 spare capacity in the economy so we were 00:45:36.239 --> 00:45:41.078 very close to Full Employment the supply 00:45:38.280 --> 00:45:42.960 side was very constrained and so on and 00:45:41.079 --> 00:45:44.800 so there may have been good reasons for 00:45:42.960 --> 00:45:46.760 the fiscal package transfers to people 00:45:44.800 --> 00:45:48.839 that you need to transfer and so on but 00:45:46.760 --> 00:45:50.839 the macroeconomic consequence of that 00:45:48.838 --> 00:45:53.358 very naturally was going to lead to 00:45:50.838 --> 00:45:56.199 overheating and and the and the FED did 00:45:53.358 --> 00:45:58.039 not respond to that and I think that's 00:45:56.199 --> 00:45:59.960 one of the reasons people think 00:45:58.039 --> 00:46:02.440 sometimes that the fed well there's no 00:45:59.960 --> 00:46:04.960 doubt exposed that the Fed was behind 00:46:02.440 --> 00:46:06.679 the curve but one of the reasons they 00:46:04.960 --> 00:46:09.599 were behind the curve is 00:46:06.679 --> 00:46:11.279 that they there was this big fiscal 00:46:09.599 --> 00:46:13.599 expansion which naturally was going to 00:46:11.280 --> 00:46:16.000 span output and they did not react to 00:46:13.599 --> 00:46:17.599 it and eventually they reacted but it 00:46:16.000 --> 00:46:19.440 took them a long time and by then we had 00:46:17.599 --> 00:46:21.160 inflation and all that okay so that's a 00:46:19.440 --> 00:46:23.280 situation in which we should have seen a 00:46:21.159 --> 00:46:24.679 picture like the opposite of this but we 00:46:23.280 --> 00:46:26.680 didn't see the picture we didn't see the 00:46:24.679 --> 00:46:30.879 monetary part and that's the reason we 00:46:26.679 --> 00:46:35.239 end up ended up with an economy that is 00:46:30.880 --> 00:46:35.240 overheating okay 00:46:37.159 --> 00:46:42.440 yeah I mean it's always it's a very 00:46:40.639 --> 00:46:43.799 uncertain environment here yeah they 00:46:42.440 --> 00:46:46.000 thought this was going to be very 00:46:43.800 --> 00:46:48.599 transitory that that that there was 00:46:46.000 --> 00:46:50.280 enough inflationary Dynamics 00:46:48.599 --> 00:46:53.119 disinflationary dynamics that that would 00:46:50.280 --> 00:46:54.640 have settled that Expos is obviously it 00:46:53.119 --> 00:46:56.200 was a mistake but it's exposed I mean 00:46:54.639 --> 00:46:57.558 there was a lot of noise and so on then 00:46:56.199 --> 00:47:00.799 it cames the 00:46:57.559 --> 00:47:03.000 the Russian war that sort of increased 00:47:00.800 --> 00:47:06.519 the price of oil dramatically and that 00:47:03.000 --> 00:47:07.440 sort of created lots of bad Dynamic so 00:47:06.519 --> 00:47:10.838 they were 00:47:07.440 --> 00:47:13.079 unlucky that part is a part that I think 00:47:10.838 --> 00:47:14.838 that that again they thought we were 00:47:13.079 --> 00:47:16.160 going through a temporary situation they 00:47:14.838 --> 00:47:17.400 didn't think that it was going to be 00:47:16.159 --> 00:47:19.879 strong enough they thought the supply 00:47:17.400 --> 00:47:23.039 side was going to expand a lot faster 00:47:19.880 --> 00:47:25.039 than it did ER so they may have been 00:47:23.039 --> 00:47:27.000 right in not fighting it but over a 00:47:25.039 --> 00:47:28.400 horizon of three years and they found 00:47:27.000 --> 00:47:31.318 everything very compressing to three 00:47:28.400 --> 00:47:34.480 months and that led to to a 00:47:31.318 --> 00:47:38.199 problem uh so the last thing I want to 00:47:34.480 --> 00:47:40.920 show you is is is is 00:47:38.199 --> 00:47:43.318 um that this mod how this mod Works in 00:47:40.920 --> 00:47:44.760 practice if you if you I mean obviously 00:47:43.318 --> 00:47:47.039 you're not going to estimate exactly the 00:47:44.760 --> 00:47:49.040 model I show you if you have a real 00:47:47.039 --> 00:47:51.920 model we have Dynamics and many more 00:47:49.039 --> 00:47:54.679 things but the the the the more complete 00:47:51.920 --> 00:47:57.440 version of what I just show you the islm 00:47:54.679 --> 00:48:01.159 show you many people have estimated sort 00:47:57.440 --> 00:48:04.039 of you know how do for 00:48:01.159 --> 00:48:06.679 example I've estimated the response of 00:48:04.039 --> 00:48:09.719 of of the economy to monetary shocks or 00:48:06.679 --> 00:48:12.039 to fiscal expansion and so on and they 00:48:09.719 --> 00:48:13.799 trace out different Dynamics different 00:48:12.039 --> 00:48:15.318 variables and and you know and check 00:48:13.800 --> 00:48:17.640 whether that's consistent with the slm 00:48:15.318 --> 00:48:19.358 framework or not and the point of this 00:48:17.639 --> 00:48:20.679 figure is that it's is very consistent 00:48:19.358 --> 00:48:22.838 with that but let me show you a little 00:48:20.679 --> 00:48:25.279 bit all time so this is the effect on 00:48:22.838 --> 00:48:27.519 different variable of a surprise 00:48:25.280 --> 00:48:29.200 increase in the in the federal funds 00:48:27.519 --> 00:48:31.000 rate that's the monetary policy rate 00:48:29.199 --> 00:48:34.159 okay federal funds rate is the is the 00:48:31.000 --> 00:48:36.039 interest rate that the FED sets and what 00:48:34.159 --> 00:48:38.920 you see that in practice what what you 00:48:36.039 --> 00:48:43.000 see is um this is the impact on retail 00:48:38.920 --> 00:48:45.960 sales on sales out really more or less 00:48:43.000 --> 00:48:48.679 and yeah in practice the output doesn't 00:48:45.960 --> 00:48:50.440 respond immediately it takes a while it 00:48:48.679 --> 00:48:52.318 takes several quarters but eventually 00:48:50.440 --> 00:48:54.400 hits you and that's one of the big 00:48:52.318 --> 00:48:56.318 issues with monetary policy today that 00:48:54.400 --> 00:48:59.280 is that clearly inflation is not under 00:48:56.318 --> 00:49:02.679 control but they have done a lot and we 00:48:59.280 --> 00:49:04.680 know that that it takes time for the 00:49:02.679 --> 00:49:07.239 economy to really perceive the full 00:49:04.679 --> 00:49:08.759 impact of a monetary policy and so 00:49:07.239 --> 00:49:10.399 that's a tension now because lots of 00:49:08.760 --> 00:49:12.920 people pushing the FED to do more 00:49:10.400 --> 00:49:14.760 because we still have 6% inflation but 00:49:12.920 --> 00:49:16.639 they have done a lot and they know the 00:49:14.760 --> 00:49:18.319 monetary policy works with lags with 00:49:16.639 --> 00:49:20.960 long and variable lags is a famous 00:49:18.318 --> 00:49:23.279 sentence and so you know it takes about 00:49:20.960 --> 00:49:25.599 six quarters to really see the mess how 00:49:23.280 --> 00:49:27.960 much mess has been cost right now it 00:49:25.599 --> 00:49:30.119 will take a while so I have to see you 00:49:27.960 --> 00:49:32.358 see output well it's more like sales the 00:49:30.119 --> 00:49:34.200 same thing initially declines slowly but 00:49:32.358 --> 00:49:35.239 but it takes a while but it does have a 00:49:34.199 --> 00:49:39.318 very large 00:49:35.239 --> 00:49:41.838 effect this is employment same 00:49:39.318 --> 00:49:44.599 thing something this these diagrams you 00:49:41.838 --> 00:49:47.000 don't you don't well this unemployment 00:49:44.599 --> 00:49:49.359 naturally the other side of it is 00:49:47.000 --> 00:49:51.559 unemployment also will build up slowly 00:49:49.358 --> 00:49:53.199 so unemployment is very low now but we 00:49:51.559 --> 00:49:55.160 don't know when you the economy really 00:49:53.199 --> 00:49:57.279 feels the impact of all the monetary 00:49:55.159 --> 00:50:01.519 policy has been done in the last eight 00:49:57.280 --> 00:50:04.280 months or so where will unemployment end 00:50:01.519 --> 00:50:05.519 and the big problem for the FED today is 00:50:04.280 --> 00:50:07.000 something that you don't need to 00:50:05.519 --> 00:50:09.838 understand until the second part of the 00:50:07.000 --> 00:50:12.838 course is that prices do decline 00:50:09.838 --> 00:50:14.400 eventually but it takes a long time so 00:50:12.838 --> 00:50:16.719 to control inflation with monetary 00:50:14.400 --> 00:50:19.160 policy takes a while a long time let's 00:50:16.719 --> 00:50:21.879 see whether the economy consumers and so 00:50:19.159 --> 00:50:24.879 on have the patience to to hang in 00:50:21.880 --> 00:50:24.880 there 00:50:25.639 --> 00:50:29.679 okay e