1 00:00:16,879 --> 00:00:24,719 but before I I I I do that before I get 2 00:00:20,399 --> 00:00:27,278 into the islm model um let me spend a 3 00:00:24,719 --> 00:00:30,559 little time telling you what is going on 4 00:00:27,278 --> 00:00:32,238 uh in the US economy and 5 00:00:30,559 --> 00:00:34,399 as as this will relate to the kind of 6 00:00:32,238 --> 00:00:37,679 things I will discuss later in the in 7 00:00:34,399 --> 00:00:39,920 this lecture so what you see there is is 8 00:00:37,679 --> 00:00:43,679 the path of net worth so wealth 9 00:00:39,920 --> 00:00:46,559 essentially of households and nonprofit 10 00:00:43,679 --> 00:00:49,238 organizations households primarily in 11 00:00:46,558 --> 00:00:50,839 the US and what you can see is that you 12 00:00:49,238 --> 00:00:53,519 know there's a more or less steady Trend 13 00:00:50,840 --> 00:00:57,000 obviously in recessions net wealth tends 14 00:00:53,520 --> 00:00:58,760 to declin ER and it certainly early on 15 00:00:57,000 --> 00:01:00,759 in the covid recession it declined very 16 00:00:58,759 --> 00:01:02,839 dramatically because the price price of 17 00:01:00,759 --> 00:01:05,599 equity the price of houses everything 18 00:01:02,840 --> 00:01:08,359 decline with the initial shock but what 19 00:01:05,599 --> 00:01:10,519 you see after that is a dramatic rise in 20 00:01:08,359 --> 00:01:14,000 wealth in the US and all around the 21 00:01:10,519 --> 00:01:15,640 world but particularly in the US and and 22 00:01:14,000 --> 00:01:18,079 what is behind that well there are two 23 00:01:15,640 --> 00:01:20,159 things are behind that but the main one 24 00:01:18,079 --> 00:01:22,879 is asset prices you know you have 25 00:01:20,159 --> 00:01:25,640 massive rallies in the equity Market the 26 00:01:22,879 --> 00:01:29,039 price of houses sort of skyrocketed 27 00:01:25,640 --> 00:01:31,280 everywhere and so on last year 2022 was 28 00:01:29,040 --> 00:01:33,240 a bad year for for asset values the 29 00:01:31,280 --> 00:01:35,640 equity Market declined pretty sharply in 30 00:01:33,239 --> 00:01:38,039 the US but it's still I mean it's a 31 00:01:35,640 --> 00:01:40,560 small decline relative to the big build 32 00:01:38,040 --> 00:01:43,399 up on wealth 33 00:01:40,560 --> 00:01:45,240 now why do I do you think that in this 34 00:01:43,399 --> 00:01:46,960 course I would be talking about this at 35 00:01:45,239 --> 00:01:49,879 this 36 00:01:46,959 --> 00:01:51,679 point what happens what do remember 37 00:01:49,879 --> 00:01:53,280 we're we're in this part of the course 38 00:01:51,680 --> 00:01:55,960 we're trying to come up with a model of 39 00:01:53,280 --> 00:01:57,599 aggregate demand and then how aggre 40 00:01:55,959 --> 00:01:59,599 demand reacts to policy that's the name 41 00:01:57,599 --> 00:02:01,839 of the game in this part of the course 42 00:01:59,599 --> 00:02:06,078 so if I tell you that wealth increase a 43 00:02:01,840 --> 00:02:06,079 lot why do you think I'm telling you 44 00:02:08,239 --> 00:02:12,439 that aggregate demand consumers feel 45 00:02:10,758 --> 00:02:14,598 rich they will tend to consume more that 46 00:02:12,439 --> 00:02:16,719 will increase aggregate demand so the 47 00:02:14,598 --> 00:02:19,280 point I'm highlighting to here is that 48 00:02:16,719 --> 00:02:21,719 there's a big force behind increasing 49 00:02:19,280 --> 00:02:24,000 aggregate demand which is consumers feel 50 00:02:21,719 --> 00:02:26,120 richer by the way something similar is 51 00:02:24,000 --> 00:02:29,000 happening in corporations and investment 52 00:02:26,120 --> 00:02:33,120 is also pretty high because of that real 53 00:02:29,000 --> 00:02:34,639 investment the other source of of of of 54 00:02:33,120 --> 00:02:37,200 increasing wealth which is not as 55 00:02:34,639 --> 00:02:39,559 dramatic as the previous one but is very 56 00:02:37,199 --> 00:02:41,518 important especially in lower income 57 00:02:39,560 --> 00:02:44,640 segments of the population which tend to 58 00:02:41,519 --> 00:02:49,680 have a higher propensity to consume is 59 00:02:44,639 --> 00:02:51,439 that ER incomes did not decline a lot 60 00:02:49,680 --> 00:02:53,879 during during 61 00:02:51,439 --> 00:02:55,840 covid and in some cases they even 62 00:02:53,878 --> 00:02:57,719 increased because of the large transfers 63 00:02:55,840 --> 00:02:59,840 that we saw from the government to 64 00:02:57,719 --> 00:03:02,239 individual households especially lower 65 00:02:59,840 --> 00:03:04,120 income households and at the same time 66 00:03:02,239 --> 00:03:07,480 there wasn't much to spend 67 00:03:04,120 --> 00:03:10,280 on so that meant that the saving rate 68 00:03:07,479 --> 00:03:12,479 also went up a lot in the US during the 69 00:03:10,280 --> 00:03:14,120 covid recession okay so people save a 70 00:03:12,479 --> 00:03:17,798 lot more that's sort of the average 71 00:03:14,120 --> 00:03:20,239 saving of household saies you know this 72 00:03:17,799 --> 00:03:22,599 is by quarter I think no by monthly but 73 00:03:20,239 --> 00:03:24,400 that's what we saw in the past look at 74 00:03:22,598 --> 00:03:25,639 during the covid recession people save a 75 00:03:24,400 --> 00:03:27,959 lot 76 00:03:25,639 --> 00:03:29,559 more and what you're seeing today is 77 00:03:27,959 --> 00:03:32,000 obviously they save a lot more that's 78 00:03:29,560 --> 00:03:34,560 part of the increasing net we worth is 79 00:03:32,000 --> 00:03:36,239 is due to this it's small relative to 80 00:03:34,560 --> 00:03:39,199 the amount of wealth we saw increased 81 00:03:36,239 --> 00:03:42,400 but but this was about this excess 82 00:03:39,199 --> 00:03:44,039 saving amounted to about 2.7 2.8 83 00:03:42,400 --> 00:03:46,158 trillion dollar so you get a sense of 84 00:03:44,039 --> 00:03:47,840 the order of magnitude and what we is 85 00:03:46,158 --> 00:03:50,519 happening now is that people are 86 00:03:47,840 --> 00:03:53,239 dissaving so now people are saving less 87 00:03:50,519 --> 00:03:56,000 than they used to because now they have 88 00:03:53,239 --> 00:03:57,840 opportunity to spend their stuff on okay 89 00:03:56,000 --> 00:04:00,318 and so that's you see massive demand for 90 00:03:57,840 --> 00:04:02,598 travel massive demand for restant hotels 91 00:04:00,318 --> 00:04:04,359 and stuff like that well that's has a 92 00:04:02,598 --> 00:04:06,238 lot to do with people had the money to 93 00:04:04,360 --> 00:04:08,360 do it they hadn't been able to do it for 94 00:04:06,239 --> 00:04:12,200 a while so now they're doing a lot of 95 00:04:08,360 --> 00:04:13,799 that why would I be telling you this now 96 00:04:12,199 --> 00:04:15,438 in the course in it is part of the 97 00:04:13,799 --> 00:04:17,439 course for the same reason I told you 98 00:04:15,438 --> 00:04:20,000 that net worth went a lot I mean people 99 00:04:17,439 --> 00:04:21,918 have the savings and they're really 100 00:04:20,000 --> 00:04:25,199 willing to spend it that puts lots of 101 00:04:21,918 --> 00:04:28,039 upward pressure on our great demand 102 00:04:25,199 --> 00:04:29,919 okay these pictures capture more or less 103 00:04:28,040 --> 00:04:31,360 the same this is captures very much much 104 00:04:29,918 --> 00:04:34,279 what I said in the previous slide you 105 00:04:31,360 --> 00:04:38,600 see the personal saving rate that's the 106 00:04:34,279 --> 00:04:40,638 average I don't remember over oh seveny 107 00:04:38,600 --> 00:04:43,039 year average and you see what happened 108 00:04:40,639 --> 00:04:46,720 during covid big spike in the saving 109 00:04:43,038 --> 00:04:48,639 rate and now big big decline in the 110 00:04:46,720 --> 00:04:51,160 saving rate where the saving rate is 111 00:04:48,639 --> 00:04:53,918 much lower than what normally is and 112 00:04:51,160 --> 00:04:55,560 remember the saving rate is is your 113 00:04:53,918 --> 00:04:57,279 income minus your consumption so if 114 00:04:55,560 --> 00:04:59,720 you're saving less you're consuming more 115 00:04:57,279 --> 00:05:00,879 relative to your income no that's that's 116 00:04:59,720 --> 00:05:03,000 the way it 117 00:05:00,879 --> 00:05:04,918 works obviously there's lots of 118 00:05:03,000 --> 00:05:06,399 heterogeneity some people made a lot of 119 00:05:04,918 --> 00:05:08,959 money some people didn't make a lot of 120 00:05:06,399 --> 00:05:11,319 money during covid H some people Save A 121 00:05:08,959 --> 00:05:15,120 Lot some people didn't save a lot and 122 00:05:11,319 --> 00:05:18,240 and and and in fact we do know that that 123 00:05:15,120 --> 00:05:20,519 sort of on the lower income segments a 124 00:05:18,240 --> 00:05:22,800 lot of the excess saving is already gone 125 00:05:20,519 --> 00:05:24,758 I mean accumulated early on but they 126 00:05:22,800 --> 00:05:27,360 spent it also much 127 00:05:24,759 --> 00:05:29,280 earlier um so but what you're beginning 128 00:05:27,360 --> 00:05:31,160 to see in some of those segments is even 129 00:05:29,279 --> 00:05:34,000 though the don't have excess savings 130 00:05:31,160 --> 00:05:36,319 they're borrowing a lot so now you see 131 00:05:34,000 --> 00:05:39,879 credit card borrowing which had declined 132 00:05:36,319 --> 00:05:42,039 a lot and now has increased quite a bit 133 00:05:39,879 --> 00:05:44,279 and again what do you borrow for well 134 00:05:42,038 --> 00:05:47,279 for consumption so that also 135 00:05:44,279 --> 00:05:49,918 funds additional consumption so for all 136 00:05:47,279 --> 00:05:52,399 these reasons in this Mo at this moment 137 00:05:49,918 --> 00:05:54,758 the US economy and many economies around 138 00:05:52,399 --> 00:05:56,839 the world are so what we call 139 00:05:54,759 --> 00:05:58,879 overheating there a lot of demand for 140 00:05:56,839 --> 00:06:01,638 the for the production that capacity of 141 00:05:58,879 --> 00:06:03,279 the economy and that translates the the 142 00:06:01,639 --> 00:06:05,199 problem say well what's wrong with that 143 00:06:03,279 --> 00:06:06,279 well the problem is something you don't 144 00:06:05,199 --> 00:06:07,639 understand at this part of the course 145 00:06:06,279 --> 00:06:11,399 you understand but you don't have a 146 00:06:07,639 --> 00:06:13,560 model for but you will have six Le six 147 00:06:11,399 --> 00:06:16,359 lectur more or less from now is that 148 00:06:13,560 --> 00:06:18,519 that leads to high inflation you don't 149 00:06:16,360 --> 00:06:20,639 know that but intuition tells you that 150 00:06:18,519 --> 00:06:23,079 is a lot of demand relative to supply 151 00:06:20,639 --> 00:06:25,720 well prices tend to go up this that 152 00:06:23,079 --> 00:06:28,680 happens in micro and it also happens in 153 00:06:25,720 --> 00:06:30,960 macro we'll learn that later but in any 154 00:06:28,680 --> 00:06:34,280 event as a result of this the US economy 155 00:06:30,959 --> 00:06:37,239 is overheating and therefore monetary 156 00:06:34,279 --> 00:06:40,318 policy has been very contractionary the 157 00:06:37,240 --> 00:06:43,360 FED has been tightening interest rate to 158 00:06:40,319 --> 00:06:45,400 cool down the economy so how does that 159 00:06:43,360 --> 00:06:47,240 happen well that's what the kind of 160 00:06:45,399 --> 00:06:52,239 things that we can answer with the islm 161 00:06:47,240 --> 00:06:54,598 model okay so the FED is very islm like 162 00:06:52,240 --> 00:06:56,400 I mean that's the way they think the 163 00:06:54,598 --> 00:06:58,719 model is richer they have more equations 164 00:06:56,399 --> 00:07:00,719 and so on but they are thinking in terms 165 00:06:58,720 --> 00:07:04,120 of the mechanism that we're about to 166 00:07:00,720 --> 00:07:06,639 sort of summarize in the eslm mod okay 167 00:07:04,120 --> 00:07:09,000 so if you have an economy that has this 168 00:07:06,639 --> 00:07:11,960 problem and you are in the Central Bank 169 00:07:09,000 --> 00:07:13,879 you need to use monetary policy well to 170 00:07:11,959 --> 00:07:16,839 understand how the thing works you need 171 00:07:13,879 --> 00:07:18,759 the eslm model that's a starting point 172 00:07:16,839 --> 00:07:21,038 then you can add bells and whistles but 173 00:07:18,759 --> 00:07:23,759 your starting point is the model we're 174 00:07:21,038 --> 00:07:25,439 about to see anyway so so what you see 175 00:07:23,759 --> 00:07:27,639 is what I was saying is that all that 176 00:07:25,439 --> 00:07:31,038 wealth all that excess saving all that 177 00:07:27,639 --> 00:07:33,639 pent up demand if you will led to lots 178 00:07:31,038 --> 00:07:35,159 of H led to a very an economy it's 179 00:07:33,639 --> 00:07:38,720 overheating and you can see here what 180 00:07:35,160 --> 00:07:41,080 happened I disentangle between a 181 00:07:38,720 --> 00:07:43,160 consumption of goods and consumption of 182 00:07:41,079 --> 00:07:44,839 services you consumption of servic is 183 00:07:43,160 --> 00:07:47,120 about two third of consumption remember 184 00:07:44,839 --> 00:07:50,519 we talk about that and goods is about 185 00:07:47,120 --> 00:07:52,879 one3 what happens is is in the scales 186 00:07:50,519 --> 00:07:56,399 are different noce this is for goods 187 00:07:52,879 --> 00:07:58,039 this that's for for services but what 188 00:07:56,399 --> 00:08:00,758 you what you see here is that you know 189 00:07:58,038 --> 00:08:03,240 that was the trend so consumption in 190 00:08:00,759 --> 00:08:06,080 Services was growing at a steady Pace 191 00:08:03,240 --> 00:08:07,720 then covid came and collapsed I mean you 192 00:08:06,079 --> 00:08:09,519 couldn't go to restaurant you couldn't 193 00:08:07,720 --> 00:08:12,080 travel you couldn't do anything so 194 00:08:09,519 --> 00:08:14,279 consumption in Services collapsed and 195 00:08:12,079 --> 00:08:17,120 now has been recovering and and and and 196 00:08:14,279 --> 00:08:19,519 that recovery pick up pace last year 197 00:08:17,120 --> 00:08:22,280 actually 2021 already pick up pace and 198 00:08:19,519 --> 00:08:24,639 by now we're above the trend okay so 199 00:08:22,279 --> 00:08:27,038 service consumption that collapsed 200 00:08:24,639 --> 00:08:29,038 during covid now has fully 201 00:08:27,038 --> 00:08:30,478 recovered while at the same time the 202 00:08:29,038 --> 00:08:32,319 capacity to produce in the service 203 00:08:30,478 --> 00:08:34,759 sector hasn't recovered equally but that 204 00:08:32,320 --> 00:08:37,479 and we'll get that to that after quiz 205 00:08:34,759 --> 00:08:40,038 one what happens to Goods consumption 206 00:08:37,479 --> 00:08:41,800 well also initially collaps but then 207 00:08:40,038 --> 00:08:43,158 well you know people were Bor at home 208 00:08:41,799 --> 00:08:45,120 they couldn't do anything they bought 209 00:08:43,158 --> 00:08:47,278 lots of gadgets and and stuff like that 210 00:08:45,120 --> 00:08:49,679 so Goods consumption went up very 211 00:08:47,278 --> 00:08:52,519 sharply during covid way above the trend 212 00:08:49,679 --> 00:08:55,199 you see there's covid collapse and then 213 00:08:52,519 --> 00:08:58,480 people began to buy all sort of gadgets 214 00:08:55,200 --> 00:09:00,320 okay and so now it's slowing down but 215 00:08:58,480 --> 00:09:02,320 still if you look rela to Trend 216 00:09:00,320 --> 00:09:03,800 consumption of goods is way above what 217 00:09:02,320 --> 00:09:05,760 would have been in the absence of this 218 00:09:03,799 --> 00:09:07,679 episode so the sum of the two things 219 00:09:05,759 --> 00:09:11,120 tells you that you have an economy with 220 00:09:07,679 --> 00:09:12,838 a lot of consumption and that and that 221 00:09:11,120 --> 00:09:15,440 at this moment the FED wants to cool 222 00:09:12,839 --> 00:09:18,440 down okay it's too much for the economy 223 00:09:15,440 --> 00:09:20,240 to take so the FED wants to cool it down 224 00:09:18,440 --> 00:09:21,680 and and we're going to see how how you 225 00:09:20,240 --> 00:09:25,440 do 226 00:09:21,679 --> 00:09:27,519 that okay so now let's get into into 227 00:09:25,440 --> 00:09:29,399 this set of lectures and please please 228 00:09:27,519 --> 00:09:32,120 stop if there's anything that is unclear 229 00:09:29,399 --> 00:09:33,360 because as I said this is probably if IA 230 00:09:32,120 --> 00:09:34,560 of the summer you have forgotten 231 00:09:33,360 --> 00:09:36,759 everything you have learned this course 232 00:09:34,559 --> 00:09:42,199 but you remember these two lectures well 233 00:09:36,759 --> 00:09:44,838 I'll be happy okay so so stop it if you 234 00:09:42,200 --> 00:09:47,278 do in fact I I normally I I I have 235 00:09:44,839 --> 00:09:49,040 taught this lecture in one I I decided 236 00:09:47,278 --> 00:09:51,720 to try to slow it down as much as I can 237 00:09:49,039 --> 00:09:53,879 because again I think it's particularly 238 00:09:51,720 --> 00:09:55,440 important for this course and for your 239 00:09:53,879 --> 00:09:57,799 stock of knowledge 240 00:09:55,440 --> 00:09:58,920 so so one of the thing the main things 241 00:09:57,799 --> 00:10:00,838 we're going to be able to do with this 242 00:09:58,919 --> 00:10:03,199 small been saying is we're going to be 243 00:10:00,839 --> 00:10:05,240 able to discuss the main macroeconomic 244 00:10:03,200 --> 00:10:07,120 policy tools which are monetary policy 245 00:10:05,240 --> 00:10:09,799 monetary policies is the main antic 246 00:10:07,120 --> 00:10:11,600 cyclical pool tool but we're also going 247 00:10:09,799 --> 00:10:14,120 to be able to understand fiscal policy 248 00:10:11,600 --> 00:10:16,200 and fiscal policy is not exactly 249 00:10:14,120 --> 00:10:17,679 equivalent to monetary policy it works 250 00:10:16,200 --> 00:10:19,200 through different mechanisms allows you 251 00:10:17,679 --> 00:10:20,838 to do things that are more targeted 252 00:10:19,200 --> 00:10:24,200 transfer resources to a specific group 253 00:10:20,839 --> 00:10:26,560 of people and so on ER and sometimes 254 00:10:24,200 --> 00:10:28,640 monetary policy is just not enough and 255 00:10:26,559 --> 00:10:31,319 the covid-19 initial recession was 256 00:10:28,639 --> 00:10:33,958 clearly a case of that and you had to go 257 00:10:31,320 --> 00:10:36,440 all in and and and we'll see what what 258 00:10:33,958 --> 00:10:38,399 what we did there it was pretty dramatic 259 00:10:36,440 --> 00:10:41,000 as an intervention I think that's the 260 00:10:38,399 --> 00:10:44,320 covid-19 recession LED probably to what 261 00:10:41,000 --> 00:10:46,320 no not probably surely to the largest 262 00:10:44,320 --> 00:10:49,278 combined packaging history of policy 263 00:10:46,320 --> 00:10:53,040 support okay in terms of monetary policy 264 00:10:49,278 --> 00:10:54,759 and uh and fiscal 265 00:10:53,039 --> 00:10:57,838 policy 266 00:10:54,759 --> 00:11:00,000 so so that's what so what we're want to 267 00:10:57,839 --> 00:11:01,320 so we're going to after these two 268 00:11:00,000 --> 00:11:03,559 lectures you're going to get to 269 00:11:01,320 --> 00:11:05,278 understand essentially uh The Joint 270 00:11:03,559 --> 00:11:07,638 determination of output and interest 271 00:11:05,278 --> 00:11:09,958 rate H and we're going to be able to 272 00:11:07,639 --> 00:11:12,480 study as I said before the impact of 273 00:11:09,958 --> 00:11:14,479 monetary and fiscal policy and this 274 00:11:12,480 --> 00:11:17,759 framework that we're going to use to 275 00:11:14,480 --> 00:11:21,800 develop to to study this is what hick 276 00:11:17,759 --> 00:11:23,799 and Hansen initially called the 277 00:11:21,799 --> 00:11:26,958 islm 278 00:11:23,799 --> 00:11:29,039 model I already sort of hinted that that 279 00:11:26,958 --> 00:11:31,239 this was coming but why do you think the 280 00:11:29,039 --> 00:11:31,240 name 281 00:11:36,919 --> 00:11:42,879 I not the that I separate that is se you 282 00:11:40,000 --> 00:11:44,399 will separate is from LM remember what 283 00:11:42,879 --> 00:11:46,559 we're trying to do here we're trying to 284 00:11:44,399 --> 00:11:48,000 look at the Joint determination of 285 00:11:46,559 --> 00:11:50,039 output and interest rate that is we're 286 00:11:48,000 --> 00:11:52,958 trying to determine at at the Joint 287 00:11:50,039 --> 00:11:55,559 equilibrium of goods markets and 288 00:11:52,958 --> 00:11:55,559 financial 289 00:11:56,278 --> 00:12:00,559 markets when we describe the equilibrium 290 00:11:58,799 --> 00:12:02,240 in the goods Market we said there is an 291 00:12:00,559 --> 00:12:06,518 alternative way of describing remember I 292 00:12:02,240 --> 00:12:07,480 said it as investment equal to savings I 293 00:12:06,519 --> 00:12:10,759 equal to 294 00:12:07,480 --> 00:12:12,200 S okay so the is part of the name comes 295 00:12:10,759 --> 00:12:14,519 from the part that has to do with 296 00:12:12,200 --> 00:12:17,879 equilibrium in the Goods Market is 297 00:12:14,519 --> 00:12:20,198 investment equal to savings and the LM 298 00:12:17,879 --> 00:12:23,679 part has to do remember L was that 299 00:12:20,198 --> 00:12:25,198 component of aggregate demand we we had 300 00:12:23,679 --> 00:12:28,159 in the financial markets we look at 301 00:12:25,198 --> 00:12:30,399 equilibrium as aggregate demand demand 302 00:12:28,159 --> 00:12:32,919 for money equal to supply of money 303 00:12:30,399 --> 00:12:36,360 supply of money was M demand for money 304 00:12:32,919 --> 00:12:38,679 was y * L of I and there therefore the 305 00:12:36,360 --> 00:12:41,240 LM part okay that's the reason that's a 306 00:12:38,679 --> 00:12:43,799 nemonic for why this model is called the 307 00:12:41,240 --> 00:12:45,159 is LM the is stands for the part that 308 00:12:43,799 --> 00:12:47,519 has to do with equilibrium in the Goods 309 00:12:45,159 --> 00:12:49,799 Market the L has to do with the part has 310 00:12:47,519 --> 00:12:51,560 to do with equilibrium Financial Market 311 00:12:49,799 --> 00:12:53,759 this model is a model that combines 312 00:12:51,559 --> 00:12:56,719 those two equilibrium okay so we're 313 00:12:53,759 --> 00:13:00,600 going to be interest interesting points 314 00:12:56,720 --> 00:13:03,160 in which both markets are in equilibrium 315 00:13:00,600 --> 00:13:06,440 that's the name of the game 316 00:13:03,159 --> 00:13:09,639 here so let's first develop the is 317 00:13:06,440 --> 00:13:12,120 relation and the yes relation is really 318 00:13:09,639 --> 00:13:15,399 going back to lecture three we're going 319 00:13:12,120 --> 00:13:19,078 to go back to lecture three use the same 320 00:13:15,399 --> 00:13:22,240 model we use in lecture three with one 321 00:13:19,078 --> 00:13:24,159 change and that change is a remember in 322 00:13:22,240 --> 00:13:26,519 in in lecture three we work a lot on a 323 00:13:24,159 --> 00:13:28,120 consumption the only endogenous the only 324 00:13:26,519 --> 00:13:30,440 function we had was a consumption 325 00:13:28,120 --> 00:13:31,879 function remember remember and then all 326 00:13:30,440 --> 00:13:33,279 the rest we took as sort of given 327 00:13:31,879 --> 00:13:35,679 government expenditure was given 328 00:13:33,278 --> 00:13:37,198 investment was given all that was given 329 00:13:35,679 --> 00:13:39,159 well we're going to relax one of those 330 00:13:37,198 --> 00:13:40,559 here and we're going to we're going to 331 00:13:39,159 --> 00:13:44,078 flesh out a little more of this 332 00:13:40,559 --> 00:13:46,838 investment here make get make it closer 333 00:13:44,078 --> 00:13:48,559 to what what a a realistic function it's 334 00:13:46,839 --> 00:13:50,639 not a constant obviously it's not to 335 00:13:48,559 --> 00:13:53,879 exogenous to equilibrium output and so 336 00:13:50,639 --> 00:13:55,639 on in fact we do know that real 337 00:13:53,879 --> 00:13:57,759 investment this is physical investment 338 00:13:55,639 --> 00:13:59,959 remember this is what is this ey is 339 00:13:57,759 --> 00:14:01,440 investment this is purchase of goods and 340 00:13:59,958 --> 00:14:03,239 services by firms for the purpose of 341 00:14:01,440 --> 00:14:05,600 building Capital Equipment structures 342 00:14:03,240 --> 00:14:07,639 and stuff like that I saw in PIAA very 343 00:14:05,600 --> 00:14:08,920 quickly I'm not into that but I see more 344 00:14:07,639 --> 00:14:11,799 or less the 345 00:14:08,919 --> 00:14:13,399 flow that somebody asked should bonds be 346 00:14:11,799 --> 00:14:15,958 included in 347 00:14:13,399 --> 00:14:20,559 investment what is the 348 00:14:15,958 --> 00:14:20,559 answer in that investment 349 00:14:24,399 --> 00:14:31,039 I should purchase of bonds be included 350 00:14:28,000 --> 00:14:31,039 in that investment 351 00:14:33,759 --> 00:14:39,759 no this is purchase of goods and 352 00:14:36,159 --> 00:14:41,360 services by firms no Capital machines 353 00:14:39,759 --> 00:14:42,759 stuff like that the other thing is a 354 00:14:41,360 --> 00:14:44,320 financial investment it's nothing to do 355 00:14:42,759 --> 00:14:46,519 with the Goods Market something that has 356 00:14:44,320 --> 00:14:49,600 to do with the financial Market not with 357 00:14:46,519 --> 00:14:51,440 a Goods Market a so that investment is 358 00:14:49,600 --> 00:14:54,159 real investment again purchase of 359 00:14:51,440 --> 00:14:55,880 capital buildings for the purpose of 360 00:14:54,159 --> 00:14:59,159 production and stuff like 361 00:14:55,879 --> 00:15:01,879 that okay and and this this in 362 00:14:59,159 --> 00:15:04,399 investment is is is a function of two 363 00:15:01,879 --> 00:15:07,439 things at least the first one is 364 00:15:04,399 --> 00:15:10,039 activity when output is high sales are 365 00:15:07,440 --> 00:15:11,920 high companies tend to invest more they 366 00:15:10,039 --> 00:15:15,879 buy more equipment they buy more 367 00:15:11,919 --> 00:15:18,240 buildings they expand okay so investment 368 00:15:15,879 --> 00:15:19,879 is an increasing function of output very 369 00:15:18,240 --> 00:15:22,039 much like consumption remember was an 370 00:15:19,879 --> 00:15:24,720 increasing function of output because 371 00:15:22,039 --> 00:15:27,559 income is increasing in output so was an 372 00:15:24,720 --> 00:15:29,319 increasing function out so this we 373 00:15:27,559 --> 00:15:31,198 already had SE functions that look like 374 00:15:29,318 --> 00:15:33,599 that and we already know what it does to 375 00:15:31,198 --> 00:15:36,359 aggregate demand no it makes that curve 376 00:15:33,600 --> 00:15:38,278 steeper remember and if the multiplier 377 00:15:36,360 --> 00:15:40,399 is behind that well investment gives you 378 00:15:38,278 --> 00:15:42,278 something similar there but there is a 379 00:15:40,399 --> 00:15:44,360 second component which is also present 380 00:15:42,278 --> 00:15:46,000 in consumption but it's not as important 381 00:15:44,360 --> 00:15:47,000 as if for investment which is the 382 00:15:46,000 --> 00:15:49,198 interest 383 00:15:47,000 --> 00:15:51,799 rate in particular when the interest 384 00:15:49,198 --> 00:15:55,359 rate goes up for any given level of 385 00:15:51,799 --> 00:15:59,679 income or output then investment goes 386 00:15:55,360 --> 00:15:59,680 down why do you think that's the case 387 00:16:02,198 --> 00:16:06,359 yes most of investment is funded with 388 00:16:04,399 --> 00:16:09,198 borrowing and borrowing becomes more 389 00:16:06,360 --> 00:16:11,240 expensive so so so you don't do it even 390 00:16:09,198 --> 00:16:13,240 if you don't need to borrow There's an 391 00:16:11,240 --> 00:16:15,399 opportunity cost of those funds you can 392 00:16:13,240 --> 00:16:16,879 use it to build machines to produce or 393 00:16:15,399 --> 00:16:20,318 you can do something else like like have 394 00:16:16,879 --> 00:16:22,759 an investment Financial investment so it 395 00:16:20,318 --> 00:16:24,479 whether you borrow or not still if the 396 00:16:22,759 --> 00:16:27,759 interest rate is 397 00:16:24,480 --> 00:16:31,399 higher the opportunity cost of building 398 00:16:27,759 --> 00:16:33,720 factories is higher High okay and and so 399 00:16:31,399 --> 00:16:35,759 that's a reason investment is decreasing 400 00:16:33,720 --> 00:16:39,040 with respect to the interest 401 00:16:35,759 --> 00:16:40,639 rate so now we go back to H our 402 00:16:39,039 --> 00:16:42,159 equilibrium in the Goods Market which we 403 00:16:40,639 --> 00:16:44,278 said production is whatever aggregate 404 00:16:42,159 --> 00:16:46,399 demand wants so output is going to be 405 00:16:44,278 --> 00:16:49,159 equal to aggregate demand aggregate 406 00:16:46,399 --> 00:16:51,600 demand is the same old aggregate demand 407 00:16:49,159 --> 00:16:53,958 we had except that now we flesh out what 408 00:16:51,600 --> 00:16:56,000 is inside that investment function there 409 00:16:53,958 --> 00:16:57,638 which we have another function is 410 00:16:56,000 --> 00:16:59,440 increasing in output like consumption 411 00:16:57,639 --> 00:17:00,680 was and 412 00:16:59,440 --> 00:17:02,920 but we also have something that is 413 00:17:00,679 --> 00:17:05,918 decreasing in the interest rate and so 414 00:17:02,919 --> 00:17:07,959 this is what we call the is relation and 415 00:17:05,919 --> 00:17:10,520 the the is relation 416 00:17:07,959 --> 00:17:12,640 therefore has all the combinations of 417 00:17:10,519 --> 00:17:16,599 output and interest rate that are 418 00:17:12,640 --> 00:17:19,799 consistent with equilibrium in the Goods 419 00:17:16,599 --> 00:17:22,918 Market listen at what I said I said the 420 00:17:19,798 --> 00:17:25,279 I relation or I curve has all the 421 00:17:22,919 --> 00:17:27,799 combinations of output and interest rate 422 00:17:25,279 --> 00:17:30,079 combinations of output and interest rate 423 00:17:27,798 --> 00:17:31,720 that are consistent with equilibrium in 424 00:17:30,079 --> 00:17:35,480 the Goods 425 00:17:31,720 --> 00:17:35,480 Market what about lecture 426 00:17:36,519 --> 00:17:44,639 three we already had that but interest 427 00:17:40,679 --> 00:17:46,200 Play No role so we found one point there 428 00:17:44,640 --> 00:17:47,440 there's one level of output which is 429 00:17:46,200 --> 00:17:49,840 consistent with equilibrium in the Goods 430 00:17:47,440 --> 00:17:51,759 Market that's what we found now since we 431 00:17:49,839 --> 00:17:53,678 have an interest rate there we have two 432 00:17:51,759 --> 00:17:55,960 variables for one curve so we can trace 433 00:17:53,679 --> 00:17:59,000 a curve which not only one 434 00:17:55,960 --> 00:18:01,640 point okay 435 00:17:59,000 --> 00:18:01,640 you can trace a 436 00:18:02,000 --> 00:18:07,200 curve 437 00:18:03,558 --> 00:18:08,918 and good and that's what we call the as 438 00:18:07,200 --> 00:18:11,279 relation 439 00:18:08,919 --> 00:18:13,080 so I remember I told you when we look at 440 00:18:11,279 --> 00:18:14,319 the Goods Market equ remember this 441 00:18:13,079 --> 00:18:15,639 diagram because you're going to come 442 00:18:14,319 --> 00:18:18,960 back to it many 443 00:18:15,640 --> 00:18:20,480 times there you are so remember when we 444 00:18:18,960 --> 00:18:22,798 look at equilibrium in the Goods Market 445 00:18:20,480 --> 00:18:24,279 we had something like that I'm I'm just 446 00:18:22,798 --> 00:18:26,119 making it curve rather than linear 447 00:18:24,279 --> 00:18:27,639 simply because I haven't specified the 448 00:18:26,119 --> 00:18:29,918 functional form of investment but 449 00:18:27,640 --> 00:18:31,640 doesn't matter really make it linear 450 00:18:29,919 --> 00:18:33,200 okay but remember we had that's the way 451 00:18:31,640 --> 00:18:35,200 we found equilibrium in the Goods Market 452 00:18:33,200 --> 00:18:37,360 we have an aggregate demand and it was 453 00:18:35,200 --> 00:18:39,240 increased the slope was positive because 454 00:18:37,359 --> 00:18:41,319 we had a margin of PR to consume that's 455 00:18:39,240 --> 00:18:43,359 the reason we had this was not flat but 456 00:18:41,319 --> 00:18:46,759 upward sloping no and we found 457 00:18:43,359 --> 00:18:49,519 equilibrium output that way okay so 458 00:18:46,759 --> 00:18:50,919 that's this is lecture three we're back 459 00:18:49,519 --> 00:18:54,558 in lecture three 460 00:18:50,919 --> 00:18:58,038 here with two things two differences the 461 00:18:54,558 --> 00:18:59,720 first one is that this ZZ curve relative 462 00:18:58,038 --> 00:19:03,599 to the one had in lecture three is a 463 00:18:59,720 --> 00:19:03,600 little steeper why is 464 00:19:12,839 --> 00:19:19,319 that why is it a little steeper than by 465 00:19:16,640 --> 00:19:21,759 steeper I mean if income goes up then 466 00:19:19,319 --> 00:19:24,519 aggregate demand goes up by more than 467 00:19:21,759 --> 00:19:24,519 than it used to go 468 00:19:25,919 --> 00:19:31,559 up exactly because what made it is 469 00:19:29,319 --> 00:19:33,158 upward sloping before was the margin of 470 00:19:31,558 --> 00:19:36,240 to consume but now there is also a 471 00:19:33,159 --> 00:19:37,880 margin of to invest which is also 472 00:19:36,240 --> 00:19:40,679 positive and that's the reason it's a 473 00:19:37,880 --> 00:19:42,799 little steeper more interesting for this 474 00:19:40,679 --> 00:19:46,038 part of the lecture though for the 475 00:19:42,798 --> 00:19:48,319 construction of the curve is that is a 476 00:19:46,038 --> 00:19:50,599 parameter that we have there in ZZ what 477 00:19:48,319 --> 00:19:52,279 are the parameters we had before in that 478 00:19:50,599 --> 00:19:55,719 curve we had things like going 479 00:19:52,279 --> 00:19:57,359 expenditure taxes the the autonomous 480 00:19:55,720 --> 00:20:00,079 consumption that's the kind of stuff 481 00:19:57,359 --> 00:20:02,519 that we had as parameters of that ZZ 482 00:20:00,079 --> 00:20:04,359 curve by parameters I mean if we change 483 00:20:02,519 --> 00:20:07,798 those parameter we shift that 484 00:20:04,359 --> 00:20:10,000 curve now for this particular ZZ we have 485 00:20:07,798 --> 00:20:14,119 an extra parameter which is very 486 00:20:10,000 --> 00:20:17,159 interesting what is that it's there I 487 00:20:14,119 --> 00:20:21,519 think it's the interest 488 00:20:17,159 --> 00:20:22,600 rate no that curve holds for some given 489 00:20:21,519 --> 00:20:24,918 interest 490 00:20:22,599 --> 00:20:26,599 rate if I move the interest I'm going to 491 00:20:24,919 --> 00:20:30,640 move this curve 492 00:20:26,599 --> 00:20:30,639 around that's very important 493 00:20:32,400 --> 00:20:36,840 one of the parameters there the star 494 00:20:34,440 --> 00:20:38,279 parameter I would say for this for this 495 00:20:36,839 --> 00:20:40,798 minute of the lecture at least for this 496 00:20:38,279 --> 00:20:43,678 moment in the lecture is the interest 497 00:20:40,798 --> 00:20:45,798 rate I can find an equilibrium because I 498 00:20:43,679 --> 00:20:47,400 couldn't find an equilibrium in the 499 00:20:45,798 --> 00:20:48,960 Goods Market if you don't tell me what 500 00:20:47,400 --> 00:20:50,360 the interest rate is because you know 501 00:20:48,960 --> 00:20:52,759 it's a curve remember I told you it's a 502 00:20:50,359 --> 00:20:54,399 relationship a curve so if I tell you I 503 00:20:52,759 --> 00:20:55,519 tell you what the interest rate is then 504 00:20:54,400 --> 00:20:58,080 you can find the equilibrium in the 505 00:20:55,519 --> 00:21:00,480 Goods Market because you can fix this 506 00:20:58,079 --> 00:21:04,480 curve 507 00:21:00,480 --> 00:21:04,480 okay that's for one given interest 508 00:21:04,679 --> 00:21:08,880 rate 509 00:21:06,240 --> 00:21:10,599 okay do do you understand that that's 510 00:21:08,880 --> 00:21:13,520 important 511 00:21:10,599 --> 00:21:16,000 yes those of you that are awake do you 512 00:21:13,519 --> 00:21:18,558 understand it or not not everyone is in 513 00:21:16,000 --> 00:21:23,359 the same page here okay 514 00:21:18,558 --> 00:21:25,278 good ER so let's now with that what 515 00:21:23,359 --> 00:21:26,240 we're going to do next is construct the 516 00:21:25,278 --> 00:21:29,599 is 517 00:21:26,240 --> 00:21:31,440 curve and and and how going remember 518 00:21:29,599 --> 00:21:33,240 what what I want to try to do is Con 519 00:21:31,440 --> 00:21:35,400 constructing the space of interest rate 520 00:21:33,240 --> 00:21:36,640 and output a curve which we're going to 521 00:21:35,400 --> 00:21:39,519 call the as 522 00:21:36,640 --> 00:21:41,799 curve at this point here we have a point 523 00:21:39,519 --> 00:21:43,319 in that curve because for one level of 524 00:21:41,798 --> 00:21:46,200 interest rate I found the equilibrium 525 00:21:43,319 --> 00:21:47,720 output so to construct the curve what I 526 00:21:46,200 --> 00:21:50,120 need to do is start moving the interest 527 00:21:47,720 --> 00:21:53,278 rate and see how the equilibrium output 528 00:21:50,119 --> 00:21:54,719 changes and that will trace a curve okay 529 00:21:53,278 --> 00:21:58,079 and that's going to be my 530 00:21:54,720 --> 00:21:59,159 is curve or relationship so let's do 531 00:21:58,079 --> 00:22:01,678 that 532 00:21:59,159 --> 00:22:03,278 that's a construction of the 533 00:22:01,679 --> 00:22:06,440 curve 534 00:22:03,278 --> 00:22:11,480 so in the previous chart we found point 535 00:22:06,440 --> 00:22:14,400 a so point a there is that point okay 536 00:22:11,480 --> 00:22:17,880 there we are we had some interest 537 00:22:14,400 --> 00:22:19,798 rate this interest rate I mean believe 538 00:22:17,880 --> 00:22:23,159 me that was a parameter of the ZZ curve 539 00:22:19,798 --> 00:22:25,038 I showed you before gave us equilibrium 540 00:22:23,159 --> 00:22:27,480 output 541 00:22:25,038 --> 00:22:29,079 a so that's a point in the yes because 542 00:22:27,480 --> 00:22:31,759 that's a combination of interest rate 543 00:22:29,079 --> 00:22:33,798 and output which is consistent with 544 00:22:31,759 --> 00:22:36,200 equilibrium in the Goods Market that's a 545 00:22:33,798 --> 00:22:38,319 point in the is that's a definition of 546 00:22:36,200 --> 00:22:40,640 is so now what I'm going to do to 547 00:22:38,319 --> 00:22:42,399 construct my is is okay let me move the 548 00:22:40,640 --> 00:22:45,640 interest rate let me raise interest rate 549 00:22:42,400 --> 00:22:48,320 from I to I prime okay that's an 550 00:22:45,640 --> 00:22:50,360 increase in the interest rate and now 551 00:22:48,319 --> 00:22:52,720 let me find what is a new equilibrium in 552 00:22:50,359 --> 00:22:54,119 the goods market for a given interest 553 00:22:52,720 --> 00:22:56,720 rate Which is higher than the one I used 554 00:22:54,119 --> 00:23:00,359 to have well that amounts to Shifting 555 00:22:56,720 --> 00:23:02,120 the ZZ curve down 556 00:23:00,359 --> 00:23:04,719 why does it increasing the interest rate 557 00:23:02,119 --> 00:23:07,119 shift the ZZ curve down the aggregate 558 00:23:04,720 --> 00:23:07,120 demand 559 00:23:07,798 --> 00:23:14,000 down it makes investment decline exactly 560 00:23:10,880 --> 00:23:16,880 B is for investment declines okay so 561 00:23:14,000 --> 00:23:19,278 that means for any given level of output 562 00:23:16,880 --> 00:23:21,360 now aggregate demand is lower because 563 00:23:19,278 --> 00:23:23,359 investment is lower and then you get the 564 00:23:21,359 --> 00:23:24,479 multiplier to do it stck no and 565 00:23:23,359 --> 00:23:26,119 therefore you tend end up with a 566 00:23:24,480 --> 00:23:27,679 declining output which is even larger 567 00:23:26,119 --> 00:23:30,119 than the declining invest the initial 568 00:23:27,679 --> 00:23:31,278 declining invest M as a result of 569 00:23:30,119 --> 00:23:34,678 increase in the interest rate that's 570 00:23:31,278 --> 00:23:37,079 what a multiplier does no so say 571 00:23:34,679 --> 00:23:42,038 interest rate increased by 100 100 basis 572 00:23:37,079 --> 00:23:45,319 points that reduce investment by a say10 573 00:23:42,038 --> 00:23:47,558 billion and equilibrium output ends up 574 00:23:45,319 --> 00:23:50,079 falling by $15 billion because of the 575 00:23:47,558 --> 00:23:52,158 multiplier and so on okay but the point 576 00:23:50,079 --> 00:23:55,119 is after I do all my convergence to this 577 00:23:52,159 --> 00:23:57,960 new lower equilibrium level of output I 578 00:23:55,119 --> 00:23:59,839 have a second point in my as curve 579 00:23:57,960 --> 00:24:02,798 because that's a combination of a new 580 00:23:59,839 --> 00:24:04,359 interest rate I prime an output that is 581 00:24:02,798 --> 00:24:06,119 consistent with equilibrium in the Goods 582 00:24:04,359 --> 00:24:07,240 Market how do I know that it's 583 00:24:06,119 --> 00:24:10,079 consistent with equili in the Goods 584 00:24:07,240 --> 00:24:12,319 Market because I'm there I'm crossing 45 585 00:24:10,079 --> 00:24:13,960 degree line that means output equal to 586 00:24:12,319 --> 00:24:15,798 aggregate demand that's equilibrium in 587 00:24:13,960 --> 00:24:19,000 the Goods 588 00:24:15,798 --> 00:24:22,400 Market okay 589 00:24:19,000 --> 00:24:25,319 so and of course you can keep going no 590 00:24:22,400 --> 00:24:26,759 and trace an entire curve and all that 591 00:24:25,319 --> 00:24:28,398 you'll do is you'll change the interest 592 00:24:26,759 --> 00:24:30,798 rate that will shift this curve then you 593 00:24:28,398 --> 00:24:31,519 do the multiplier and endend up with a 594 00:24:30,798 --> 00:24:33,480 new 595 00:24:31,519 --> 00:24:35,720 equilibrium and that's another point for 596 00:24:33,480 --> 00:24:38,240 your curve 597 00:24:35,720 --> 00:24:40,440 okay so is it clear how we constructed 598 00:24:38,240 --> 00:24:40,440 that 599 00:24:41,000 --> 00:24:47,480 curve very important okay 600 00:24:45,119 --> 00:24:49,678 good it's also very important to 601 00:24:47,480 --> 00:24:52,798 understand well so why is it downward 602 00:24:49,679 --> 00:24:52,798 sloping yeah that's a 603 00:24:55,440 --> 00:25:00,120 question why is it downward sloping 604 00:25:02,919 --> 00:25:07,000 what does it mean that it's downward 605 00:25:04,440 --> 00:25:08,759 slope that means that combination of 606 00:25:07,000 --> 00:25:11,079 output and interest rate that are 607 00:25:08,759 --> 00:25:13,919 consistent with equilibrium output are 608 00:25:11,079 --> 00:25:16,918 negatively correlated meaning you know I 609 00:25:13,919 --> 00:25:20,399 have a combination of high output and 610 00:25:16,919 --> 00:25:24,120 low interest rate is consistent 611 00:25:20,398 --> 00:25:26,000 or low high interest rate and low output 612 00:25:24,119 --> 00:25:28,759 that's what I find 613 00:25:26,000 --> 00:25:32,519 here but why is that why what is the 614 00:25:28,759 --> 00:25:35,038 logic of that behind that or the 615 00:25:32,519 --> 00:25:38,398 mechanism well the way to think about 616 00:25:35,038 --> 00:25:41,960 that is exactly the way I I did this 617 00:25:38,398 --> 00:25:44,959 experiment is okay let me think what 618 00:25:41,960 --> 00:25:46,880 happens if I increase the interest rate 619 00:25:44,960 --> 00:25:49,120 and I keep the level of output where it 620 00:25:46,880 --> 00:25:51,559 was so what happens if I increase the 621 00:25:49,119 --> 00:25:53,599 interest rate and I I keep the level of 622 00:25:51,558 --> 00:25:56,000 output at the level it 623 00:25:53,599 --> 00:25:58,359 was my claim is that that's not an 624 00:25:56,000 --> 00:26:00,640 equilibrium in the Goods Market what 625 00:25:58,359 --> 00:26:00,639 what is 626 00:26:02,839 --> 00:26:06,959 it so I'm saying suppose I increase the 627 00:26:05,519 --> 00:26:10,200 interest rate but I keep the output 628 00:26:06,960 --> 00:26:12,919 constant so output is here higher 629 00:26:10,200 --> 00:26:15,519 interest rate aggregate demand is 630 00:26:12,919 --> 00:26:16,960 there so what what is the problem I'm 631 00:26:15,519 --> 00:26:18,158 saying my claim is that's not an 632 00:26:16,960 --> 00:26:19,880 equilibrium in the Goods Market we're 633 00:26:18,159 --> 00:26:21,080 going to need a lower level of output to 634 00:26:19,880 --> 00:26:22,799 have an equilibrium in the Goods Market 635 00:26:21,079 --> 00:26:24,278 that's the reason it's downward sloping 636 00:26:22,798 --> 00:26:25,158 but why is that not an equilibrium in 637 00:26:24,278 --> 00:26:27,599 the Goods 638 00:26:25,159 --> 00:26:29,360 Market or what is the nature of the dise 639 00:26:27,599 --> 00:26:32,359 equilibrium in the Market there what do 640 00:26:29,359 --> 00:26:35,599 we have an excess demand excess 641 00:26:32,359 --> 00:26:37,639 Supply excess Supply meaning there isn't 642 00:26:35,599 --> 00:26:41,278 enough demand to support that 643 00:26:37,640 --> 00:26:43,960 Supply so supply has to fall in order to 644 00:26:41,278 --> 00:26:47,119 restore equilibrium in that market in 645 00:26:43,960 --> 00:26:49,480 the Goods Market okay and since one 646 00:26:47,119 --> 00:26:51,839 drags the other one it has to Fall by a 647 00:26:49,480 --> 00:26:53,960 lot that that has to do with the slope 648 00:26:51,839 --> 00:26:56,678 of this 649 00:26:53,960 --> 00:26:58,120 curve that's the reason it's negatively 650 00:26:56,679 --> 00:26:59,120 so that's first thing you have to 651 00:26:58,119 --> 00:27:02,398 understand understand when you construct 652 00:26:59,119 --> 00:27:05,759 this curve I know I'm going slowly but 653 00:27:02,398 --> 00:27:08,000 it's important when you con please try 654 00:27:05,759 --> 00:27:11,278 to 655 00:27:08,000 --> 00:27:12,519 understand why is that another way of 656 00:27:11,278 --> 00:27:15,480 saying 657 00:27:12,519 --> 00:27:18,038 it when I when I find the when I change 658 00:27:15,480 --> 00:27:21,720 the equilibrium output along this S 659 00:27:18,038 --> 00:27:25,158 curve by moving the inid around what I'm 660 00:27:21,720 --> 00:27:27,399 doing is I'm moving along an is curve 661 00:27:25,159 --> 00:27:30,480 okay so if I if the only reason why 662 00:27:27,398 --> 00:27:32,439 equilibrium out with is changing is 663 00:27:30,480 --> 00:27:35,079 because I'm moving the interest rate 664 00:27:32,440 --> 00:27:37,880 that's a movement along the S 665 00:27:35,079 --> 00:27:41,599 curve okay so I'm I'm tracing points of 666 00:27:37,880 --> 00:27:43,799 the as curve good and I want to draw a 667 00:27:41,599 --> 00:27:47,719 contrast between these movements along 668 00:27:43,798 --> 00:27:49,558 the is curve versus things that shift 669 00:27:47,720 --> 00:27:52,919 the 670 00:27:49,558 --> 00:27:54,879 curve okay for 671 00:27:52,919 --> 00:28:00,120 example 672 00:27:54,880 --> 00:28:00,120 that so suppose I increase taxes 673 00:28:00,398 --> 00:28:05,798 increase taxes the government increases 674 00:28:02,519 --> 00:28:07,480 taxes my claim is that the is shift to 675 00:28:05,798 --> 00:28:11,200 the 676 00:28:07,480 --> 00:28:13,880 left that is for any given level of 677 00:28:11,200 --> 00:28:17,440 interest rate pick any interest you 678 00:28:13,880 --> 00:28:19,760 want say this one you're going to have a 679 00:28:17,440 --> 00:28:22,038 lower equilibrium output consistent with 680 00:28:19,759 --> 00:28:23,839 that interest rate if you have a lower 681 00:28:22,038 --> 00:28:26,200 equilibrium consistent with the same 682 00:28:23,839 --> 00:28:30,038 interest rate that has shifted the 683 00:28:26,200 --> 00:28:32,200 is has to be a different is 684 00:28:30,038 --> 00:28:33,759 okay and and think that I can do that 685 00:28:32,200 --> 00:28:35,558 for any given level of in I pick this 686 00:28:33,759 --> 00:28:37,000 one but I could have pick that one would 687 00:28:35,558 --> 00:28:38,480 have been the same I'm saying you 688 00:28:37,000 --> 00:28:40,440 increase 689 00:28:38,480 --> 00:28:41,839 taxes that's going to lead to lower 690 00:28:40,440 --> 00:28:45,720 equilibrium 691 00:28:41,839 --> 00:28:47,519 output so that means that for this 692 00:28:45,720 --> 00:28:49,679 higher level of taxes I will have to 693 00:28:47,519 --> 00:28:51,759 trace a different test 694 00:28:49,679 --> 00:28:53,440 curve I can start moving the interest 695 00:28:51,759 --> 00:28:54,919 rate around but I'm going to have a 696 00:28:53,440 --> 00:28:57,200 lower level of output for any given 697 00:28:54,919 --> 00:28:59,440 level of interest rate because I have 698 00:28:57,200 --> 00:29:02,038 higher taxes 699 00:28:59,440 --> 00:29:05,120 so how do I know that an increas in 700 00:29:02,038 --> 00:29:09,759 taxes will do this Which diagram would 701 00:29:05,119 --> 00:29:09,759 you go to to try to understand 702 00:29:14,519 --> 00:29:19,599 this so or let me ask it 703 00:29:17,679 --> 00:29:21,159 differently how do I know that this 704 00:29:19,599 --> 00:29:23,759 stuff shift to the left so I give you 705 00:29:21,159 --> 00:29:25,559 more open space how do I know that this 706 00:29:23,759 --> 00:29:27,839 increasing taxes will shift this is 707 00:29:25,558 --> 00:29:30,038 curve to the left how would you go about 708 00:29:27,839 --> 00:29:30,038 thinking 709 00:29:36,079 --> 00:29:40,278 not going to spend as much money less 710 00:29:38,440 --> 00:29:41,840 outcome there will be less aggregate 711 00:29:40,278 --> 00:29:43,240 demand and less aggregate demand leads 712 00:29:41,839 --> 00:29:45,319 to less output because output is 713 00:29:43,240 --> 00:29:47,880 aggregate demand deter exactly that's 714 00:29:45,319 --> 00:29:50,038 what equilibrium in the Goods Market so 715 00:29:47,880 --> 00:29:52,960 you can go back to this diagram this 716 00:29:50,038 --> 00:29:55,240 goes in the I could say ignore these 717 00:29:52,960 --> 00:29:57,558 labels here and say look for any given 718 00:29:55,240 --> 00:30:00,399 level of interest rate pick any if I 719 00:29:57,558 --> 00:30:01,278 increase tax I'm going to shift the Z ZZ 720 00:30:00,398 --> 00:30:04,439 curve 721 00:30:01,278 --> 00:30:07,000 down okay so ignore the this charar 722 00:30:04,440 --> 00:30:08,880 suppose that I fix the interest rate but 723 00:30:07,000 --> 00:30:10,000 I now change taxes increase taxes well 724 00:30:08,880 --> 00:30:11,559 I'm going to do exactly the same here 725 00:30:10,000 --> 00:30:13,159 I'm going to move this down and it's 726 00:30:11,558 --> 00:30:14,678 going to be a different is curve though 727 00:30:13,159 --> 00:30:17,120 because I shouldn't have used this 728 00:30:14,679 --> 00:30:20,159 diagram let me keep your answer I should 729 00:30:17,119 --> 00:30:23,319 have put a new diagram but it's it's 730 00:30:20,159 --> 00:30:25,919 lecture three in lecture three we did 731 00:30:23,319 --> 00:30:28,599 see that that an increase in tax would 732 00:30:25,919 --> 00:30:31,159 lead to lower equilibrium output 733 00:30:28,599 --> 00:30:33,759 in fact we know exactly by how much if 734 00:30:31,159 --> 00:30:36,159 if taxes increase by 100 then you know 735 00:30:33,759 --> 00:30:39,359 that equilibrium output would decline by 736 00:30:36,159 --> 00:30:42,200 C1 times 1 / minus 737 00:30:39,359 --> 00:30:44,278 C1 changing taxes here would be a little 738 00:30:42,200 --> 00:30:47,319 different because there is also remember 739 00:30:44,278 --> 00:30:50,599 investment also has a propensity to to 740 00:30:47,319 --> 00:30:52,079 to to spend as a function of output so 741 00:30:50,599 --> 00:30:53,319 so it would be a little different but 742 00:30:52,079 --> 00:30:57,000 that's the kind of 743 00:30:53,319 --> 00:30:59,918 calculation okay what else would shift 744 00:30:57,000 --> 00:30:59,919 the the is this 745 00:31:04,119 --> 00:31:07,678 way decrease in governance friend would 746 00:31:06,440 --> 00:31:09,840 do that what 747 00:31:07,679 --> 00:31:12,399 else this this another thing I want you 748 00:31:09,839 --> 00:31:13,720 to think of any everything because for 749 00:31:12,398 --> 00:31:16,359 sure you're going to face that in the 750 00:31:13,720 --> 00:31:20,480 quiz that anything that would shift the 751 00:31:16,359 --> 00:31:20,479 curve what else would shift the 752 00:31:23,000 --> 00:31:28,038 curve yeah that's true but but but 753 00:31:25,919 --> 00:31:30,519 that's not for this part of the course 754 00:31:28,038 --> 00:31:33,919 remember we're in a close economy so 755 00:31:30,519 --> 00:31:35,278 here we assume xal to m equal to zero I 756 00:31:33,919 --> 00:31:40,440 equal to 757 00:31:35,278 --> 00:31:40,440 zero that comes from after quiz one what 758 00:31:43,839 --> 00:31:48,000 else things that were captur remember 759 00:31:46,200 --> 00:31:49,919 when I began this lecture I show you 760 00:31:48,000 --> 00:31:51,720 wealth what had happened and so on well 761 00:31:49,919 --> 00:31:55,038 there's nowhere wealth in this model 762 00:31:51,720 --> 00:31:58,000 here it's just output but wealth affects 763 00:31:55,038 --> 00:31:59,519 how much consumers consume so autonomous 764 00:31:58,000 --> 00:32:02,038 consumption there were lots of stuff 765 00:31:59,519 --> 00:32:05,519 hidden in that c0 that constant c0 766 00:32:02,038 --> 00:32:08,839 remember c0 plus C1 one well c0 captures 767 00:32:05,519 --> 00:32:10,720 things like how confident were consumers 768 00:32:08,839 --> 00:32:13,519 how wealthy they felt and stuff like 769 00:32:10,720 --> 00:32:15,839 that so anything that shift C down 770 00:32:13,519 --> 00:32:17,720 consumer sentiment declines wealth 771 00:32:15,839 --> 00:32:23,759 declines something like that will also 772 00:32:17,720 --> 00:32:23,759 shift yes to the left okay so that's 773 00:32:23,880 --> 00:32:29,159 important good so now so we're done with 774 00:32:28,000 --> 00:32:32,558 is for 775 00:32:29,159 --> 00:32:34,960 now now with the is alone I cannot find 776 00:32:32,558 --> 00:32:38,359 what I want I want to find equili 777 00:32:34,960 --> 00:32:40,319 combinations of interest rate and output 778 00:32:38,359 --> 00:32:42,959 that are consistent with equilibrium in 779 00:32:40,319 --> 00:32:44,678 the goods and financial markets this 780 00:32:42,960 --> 00:32:46,519 doesn't do it because it gives you only 781 00:32:44,679 --> 00:32:50,320 combinations that are consistent with 782 00:32:46,519 --> 00:32:54,839 equilibrium in the Goods Market 783 00:32:50,319 --> 00:32:56,398 okay and in fact okay so I now need to 784 00:32:54,839 --> 00:32:58,918 look at Financial Market which is the 785 00:32:56,398 --> 00:33:01,638 other side the LM relation ship and 786 00:32:58,919 --> 00:33:03,679 remember what we had is we had 787 00:33:01,638 --> 00:33:05,359 equilibrium in the in the financial 788 00:33:03,679 --> 00:33:06,720 Market we had two instruments that we 789 00:33:05,359 --> 00:33:10,000 could use remember we had only two 790 00:33:06,720 --> 00:33:13,120 assets money and bonds so we could look 791 00:33:10,000 --> 00:33:16,638 at the equilibrium in in in the in money 792 00:33:13,119 --> 00:33:20,158 or equilibrium in bonds is the 793 00:33:16,638 --> 00:33:22,240 same but we we did it all in in terms of 794 00:33:20,159 --> 00:33:23,600 money it's the same because given wealth 795 00:33:22,240 --> 00:33:26,000 if one is in equilibrium the other one 796 00:33:23,599 --> 00:33:28,519 has to be in equilibrium as well so I I 797 00:33:26,000 --> 00:33:32,240 only need to look at one and we're 798 00:33:28,519 --> 00:33:33,319 looking at money okay so money is equal 799 00:33:32,240 --> 00:33:35,960 to money 800 00:33:33,319 --> 00:33:37,480 demand I'm going to divide both sides by 801 00:33:35,960 --> 00:33:39,600 P this is not going to be very important 802 00:33:37,480 --> 00:33:41,720 now but later we will be and so we're 803 00:33:39,599 --> 00:33:43,959 going to have that this is is 804 00:33:41,720 --> 00:33:47,480 equilibrium in in in financial Market 805 00:33:43,960 --> 00:33:50,519 means that real real H money supply 806 00:33:47,480 --> 00:33:52,798 equals real money demand okay that's 807 00:33:50,519 --> 00:33:56,720 what we have 808 00:33:52,798 --> 00:33:58,720 here so this you already see it traces 809 00:33:56,720 --> 00:34:00,880 combinations of out put an interest rate 810 00:33:58,720 --> 00:34:01,960 which are consistent with equilibrium in 811 00:34:00,880 --> 00:34:03,880 financial 812 00:34:01,960 --> 00:34:07,000 markets 813 00:34:03,880 --> 00:34:08,320 okay in the past that's the way the LM 814 00:34:07,000 --> 00:34:11,760 would be 815 00:34:08,320 --> 00:34:14,399 described we would fix M and say well 816 00:34:11,760 --> 00:34:18,000 this will give you an upward sloping 817 00:34:14,398 --> 00:34:21,078 curve no because this is downward 818 00:34:18,000 --> 00:34:22,838 sloping so if this guy goes up I need to 819 00:34:21,079 --> 00:34:24,399 if this is constant this guy goes up 820 00:34:22,838 --> 00:34:27,440 well this guy needs to come down what 821 00:34:24,398 --> 00:34:30,000 does that what does bring L down well I 822 00:34:27,440 --> 00:34:32,679 go up because L Prime is negative so 823 00:34:30,000 --> 00:34:35,239 that's the way LM used to be described 824 00:34:32,679 --> 00:34:38,079 your life is a lot simpler today it's a 825 00:34:35,239 --> 00:34:39,719 lot simpler because central banks don't 826 00:34:38,079 --> 00:34:41,440 Target monetary aggates they don't 827 00:34:39,719 --> 00:34:43,158 Target M they target the interest rate 828 00:34:41,440 --> 00:34:44,480 directly so they tell you the answer 829 00:34:43,159 --> 00:34:47,320 already they 830 00:34:44,480 --> 00:34:50,039 said what Central Bank when it does 831 00:34:47,320 --> 00:34:53,079 policy says look I tell you what I will 832 00:34:50,039 --> 00:34:54,679 be then if output moves around whatever 833 00:34:53,079 --> 00:34:56,639 that's that's problem it's a problem for 834 00:34:54,679 --> 00:34:58,599 M we'll provide the M that the market 835 00:34:56,639 --> 00:35:02,280 needs in order to have interest rate 836 00:34:58,599 --> 00:35:04,838 equal to the one we want okay so so it's 837 00:35:02,280 --> 00:35:06,480 it's it it is true that it captures all 838 00:35:04,838 --> 00:35:07,639 the combinations of output and interest 839 00:35:06,480 --> 00:35:09,400 that are consistent with equilibrium in 840 00:35:07,639 --> 00:35:13,799 the financial markets but it's very 841 00:35:09,400 --> 00:35:17,000 simple because the the the what the FED 842 00:35:13,800 --> 00:35:18,560 does in the US other central banks do is 843 00:35:17,000 --> 00:35:21,480 they say okay this is the interest rate 844 00:35:18,559 --> 00:35:23,960 we want and now you can put any amount 845 00:35:21,480 --> 00:35:26,400 of output you want as long as we remain 846 00:35:23,960 --> 00:35:27,920 committed to this interest rate it will 847 00:35:26,400 --> 00:35:30,440 be consistent with equilibrium in the in 848 00:35:27,920 --> 00:35:32,800 the financial markets because we will do 849 00:35:30,440 --> 00:35:35,240 it so and the way we will do it so is 850 00:35:32,800 --> 00:35:37,519 we'll provide as much M as the market 851 00:35:35,239 --> 00:35:38,719 needs so that that combination of output 852 00:35:37,519 --> 00:35:41,039 and interest rate is an equilibrium in 853 00:35:38,719 --> 00:35:43,719 the financial Market that is that's a 854 00:35:41,039 --> 00:35:49,400 very long way of saying that the FED 855 00:35:43,719 --> 00:35:52,078 sets I and then m is whatever this is 856 00:35:49,400 --> 00:35:54,400 needed for this equation to be in 857 00:35:52,079 --> 00:35:55,839 equilibrium so if output Rises and The 858 00:35:54,400 --> 00:35:58,639 Fed doesn't want to change the interest 859 00:35:55,838 --> 00:36:01,199 rate that means you need to change m 860 00:35:58,639 --> 00:36:04,000 okay so suppose that the FED says I want 861 00:36:01,199 --> 00:36:07,919 this interest rate to be fixed at this 862 00:36:04,000 --> 00:36:10,639 level call it I zero and now output 863 00:36:07,920 --> 00:36:10,639 turns out to be 864 00:36:10,760 --> 00:36:16,920 higher what will the FED do in order to 865 00:36:13,400 --> 00:36:18,880 ensure that I remains at i z what if the 866 00:36:16,920 --> 00:36:21,480 FED doesn't do 867 00:36:18,880 --> 00:36:23,318 anything so the FED says I want I equals 868 00:36:21,480 --> 00:36:26,000 z and and the FED is calculated that 869 00:36:23,318 --> 00:36:29,279 output will be about certain level and 870 00:36:26,000 --> 00:36:32,480 it turns out that output is higher 871 00:36:29,280 --> 00:36:32,480 what happens if the FED doesn't 872 00:36:32,559 --> 00:36:38,960 react and keeps the interest rate at I 873 00:36:35,480 --> 00:36:42,519 zero and output T to be higher than what 874 00:36:38,960 --> 00:36:44,559 they thought when they provided the M 875 00:36:42,519 --> 00:36:47,239 that they thought the market needed to 876 00:36:44,559 --> 00:36:49,599 be in equilibrium of that interest rate 877 00:36:47,239 --> 00:36:49,598 what will 878 00:36:51,159 --> 00:36:56,358 happen well the interest rate will go up 879 00:36:54,280 --> 00:36:57,960 because money demand will exceed money 880 00:36:56,358 --> 00:36:59,440 supply well the only way to restory 881 00:36:57,960 --> 00:37:02,639 equilibrium is for interest rate to go 882 00:36:59,440 --> 00:37:04,519 up but the FED doesn't want that so what 883 00:37:02,639 --> 00:37:06,679 the FED will do is when it feels that it 884 00:37:04,519 --> 00:37:09,039 feels the interest rat are going up they 885 00:37:06,679 --> 00:37:10,559 will provide more money so so they can 886 00:37:09,039 --> 00:37:13,559 restore equilibrium in the financial 887 00:37:10,559 --> 00:37:15,159 Market at that level of interest rate 888 00:37:13,559 --> 00:37:17,318 despite the fact that output end up 889 00:37:15,159 --> 00:37:19,279 being higher than they thought so all 890 00:37:17,318 --> 00:37:23,880 this is a long winded way to say that 891 00:37:19,280 --> 00:37:23,880 the LM is the modern LM is 892 00:37:24,838 --> 00:37:30,559 horizontal a few years ago that curve 893 00:37:27,760 --> 00:37:32,160 would have been upward sloping but given 894 00:37:30,559 --> 00:37:35,480 the way monetary policy is conducted 895 00:37:32,159 --> 00:37:38,519 nowadays your life is a lot simpler the 896 00:37:35,480 --> 00:37:41,679 L is a horizontal curve okay the FED 897 00:37:38,519 --> 00:37:43,318 tells you the Central Bank tells you H 898 00:37:41,679 --> 00:37:45,199 what the interest rate has to be and 899 00:37:43,318 --> 00:37:47,239 then it will give whatever M will 900 00:37:45,199 --> 00:37:50,199 provide whatever m is needed so that's 901 00:37:47,239 --> 00:37:50,199 the equilibrium 902 00:37:53,440 --> 00:37:59,318 industry so what shift the modern LM 903 00:37:59,760 --> 00:38:04,160 and by modern I only mean the book 904 00:38:02,159 --> 00:38:07,440 doesn't use the terminology but by 905 00:38:04,159 --> 00:38:09,759 modern I mean that the FED decides what 906 00:38:07,440 --> 00:38:12,000 the interest it 907 00:38:09,760 --> 00:38:13,359 is exactly the only thing that will 908 00:38:12,000 --> 00:38:16,559 shift into to your life is very simple 909 00:38:13,358 --> 00:38:21,480 the only thing that will shift the mod 910 00:38:16,559 --> 00:38:23,759 LM is that the FED changes its 911 00:38:21,480 --> 00:38:24,960 mind a few years back it would have been 912 00:38:23,760 --> 00:38:28,119 more 913 00:38:24,960 --> 00:38:29,838 complicated a change in money demand 914 00:38:28,119 --> 00:38:32,640 a a change in money supply all those 915 00:38:29,838 --> 00:38:35,679 things will be Shifting the LM around 916 00:38:32,639 --> 00:38:37,719 now in this setup is very simple no it 917 00:38:35,679 --> 00:38:41,358 will change only if the feds changes his 918 00:38:37,719 --> 00:38:43,519 mind now obviously the FED is not just a 919 00:38:41,358 --> 00:38:45,960 moody institution it will change the 920 00:38:43,519 --> 00:38:46,838 mind and sometimes is forced to change 921 00:38:45,960 --> 00:38:48,880 its 922 00:38:46,838 --> 00:38:50,480 mind I mean they're not happy with the 923 00:38:48,880 --> 00:38:53,079 interest rate they're setting 924 00:38:50,480 --> 00:38:55,079 nowadays they' been forced into that 925 00:38:53,079 --> 00:38:57,119 were very reluctant to go into very high 926 00:38:55,079 --> 00:38:59,599 interest rate but you know what is 927 00:38:57,119 --> 00:39:01,000 happening around with very high 928 00:38:59,599 --> 00:39:02,760 consumption and the impact that it's 929 00:39:01,000 --> 00:39:05,599 having on inflation they have been 930 00:39:02,760 --> 00:39:07,800 forced into moving interest rate not 931 00:39:05,599 --> 00:39:11,119 only very high but also very fast and 932 00:39:07,800 --> 00:39:13,440 and and and uh that was very risky we 933 00:39:11,119 --> 00:39:15,880 have been lucky that that nothing has 934 00:39:13,440 --> 00:39:18,880 really broken when normally when central 935 00:39:15,880 --> 00:39:20,519 banks raise interest so fast they break 936 00:39:18,880 --> 00:39:22,240 something along the way somebody's very 937 00:39:20,519 --> 00:39:24,559 lever out there some bank or something 938 00:39:22,239 --> 00:39:26,959 like that and you can you can blow up 939 00:39:24,559 --> 00:39:29,599 the UK we had a little scare with some 940 00:39:26,960 --> 00:39:33,199 insurance companies but 941 00:39:29,599 --> 00:39:36,039 but but was for a different reason 942 00:39:33,199 --> 00:39:37,919 but but it's it's scary to move policy 943 00:39:36,039 --> 00:39:40,318 very fast because this is a very 944 00:39:37,920 --> 00:39:42,400 important price for financial markets 945 00:39:40,318 --> 00:39:44,719 everything in financial Market gets 946 00:39:42,400 --> 00:39:47,519 priced off that's a starting any pricing 947 00:39:44,719 --> 00:39:49,159 model for stocks for anything will start 948 00:39:47,519 --> 00:39:51,000 from that policy rate then everything 949 00:39:49,159 --> 00:39:53,318 builds from there so if this has to move 950 00:39:51,000 --> 00:39:56,079 fast you can have lots of 951 00:39:53,318 --> 00:39:57,800 dislocation so my goal for today is to 952 00:39:56,079 --> 00:39:58,839 just to give you the instr and then 953 00:39:57,800 --> 00:40:00,160 we're going to all talk about 954 00:39:58,838 --> 00:40:02,440 combinations things that we did in 955 00:40:00,159 --> 00:40:06,239 certain episodes and and things of that 956 00:40:02,440 --> 00:40:08,240 kind okay good so again this part of the 957 00:40:06,239 --> 00:40:10,519 course is this part of the of the ISL 958 00:40:08,239 --> 00:40:13,679 mod is very easy and it's a lot easier 959 00:40:10,519 --> 00:40:17,639 now than it was a few years back okay so 960 00:40:13,679 --> 00:40:20,719 what does the eslm mo the slm M me 961 00:40:17,639 --> 00:40:22,838 simply mean puts the two curves together 962 00:40:20,719 --> 00:40:25,078 now we have two Curves in the space of 963 00:40:22,838 --> 00:40:27,000 output and interest rate and two 964 00:40:25,079 --> 00:40:29,318 unknowns which is output and interest 965 00:40:27,000 --> 00:40:29,318 rate 966 00:40:29,519 --> 00:40:36,559 so we have one combination only a that 967 00:40:33,679 --> 00:40:39,559 is consistent with both equilibrium in 968 00:40:36,559 --> 00:40:42,880 the Goods Market and equilibrium in 969 00:40:39,559 --> 00:40:45,199 financial Market that's the point 970 00:40:42,880 --> 00:40:48,318 a 971 00:40:45,199 --> 00:40:51,159 okay what happens to points to the right 972 00:40:48,318 --> 00:40:55,599 suppose I I I what happen What Happens 973 00:40:51,159 --> 00:40:55,598 here if I show you this point in this 974 00:40:56,000 --> 00:41:00,280 space what what's wrong with that 975 00:41:05,318 --> 00:41:12,239 point so point to the a point along the 976 00:41:08,119 --> 00:41:12,240 lamp but to the right what's wrong 977 00:41:15,358 --> 00:41:21,960 there well if it is along the LM I know 978 00:41:19,639 --> 00:41:23,279 that I'm okay with financial Market that 979 00:41:21,960 --> 00:41:25,519 those points are consistent with 980 00:41:23,280 --> 00:41:27,800 equilibrium in financial 981 00:41:25,519 --> 00:41:28,880 Market but it's not my equilibrium and 982 00:41:27,800 --> 00:41:30,079 it has to be in consistent with the 983 00:41:28,880 --> 00:41:33,160 other one it's not consistent with 984 00:41:30,079 --> 00:41:35,280 equilibrium in the Goods Market in fact 985 00:41:33,159 --> 00:41:37,118 you know more than that what's wrong 986 00:41:35,280 --> 00:41:39,920 with Goods Market there's an imbalance 987 00:41:37,119 --> 00:41:39,920 there but in which 988 00:41:40,960 --> 00:41:44,480 direction that point 989 00:41:47,838 --> 00:41:51,838 here what do you mean by excess of 990 00:41:52,480 --> 00:41:57,960 goods no demand is exactly insufficient 991 00:41:55,119 --> 00:41:59,280 demand there's too much output for that 992 00:41:57,960 --> 00:42:01,240 demand so that's the reason it's not 993 00:41:59,280 --> 00:42:05,680 consistent with equilibrium in the Goods 994 00:42:01,239 --> 00:42:08,559 Market okay to the left is the opposite 995 00:42:05,679 --> 00:42:10,559 no to the left we have insufficient 996 00:42:08,559 --> 00:42:12,159 output for the demand we have so it's 997 00:42:10,559 --> 00:42:14,480 not consistent with equilibrium in the 998 00:42:12,159 --> 00:42:17,078 the Goods Market so the only point that 999 00:42:14,480 --> 00:42:20,318 is consistent oh well you can think what 1000 00:42:17,079 --> 00:42:22,960 happens with a point here for 1001 00:42:20,318 --> 00:42:24,400 example that point because it's in the 1002 00:42:22,960 --> 00:42:26,480 curve is consistent with equilibrium in 1003 00:42:24,400 --> 00:42:29,639 the Goods Market but it's not consistent 1004 00:42:26,480 --> 00:42:31,960 with equilibrium in Financial Market 1005 00:42:29,639 --> 00:42:34,519 okay what do we have there supposed 1006 00:42:31,960 --> 00:42:36,000 having in that point the interest rate 1007 00:42:34,519 --> 00:42:38,280 is too high so that means the money 1008 00:42:36,000 --> 00:42:40,159 demand is low so too much money demand 1009 00:42:38,280 --> 00:42:43,160 for money supply okay that's that's what 1010 00:42:40,159 --> 00:42:44,719 you have so those are not so so that's 1011 00:42:43,159 --> 00:42:46,960 at the end of the day you know this is 1012 00:42:44,719 --> 00:42:48,598 the only equilibrium point we have and 1013 00:42:46,960 --> 00:42:51,440 and all the experiments I want to do 1014 00:42:48,599 --> 00:42:53,760 next have to do with moving one curve or 1015 00:42:51,440 --> 00:42:57,000 the other and see what happens to trace 1016 00:42:53,760 --> 00:42:57,760 new equilibrium points okay but try to 1017 00:42:57,000 --> 00:43:00,480 understand 1018 00:42:57,760 --> 00:43:03,640 very well these diagrams of what 1019 00:43:00,480 --> 00:43:05,440 happens when I move up horizontally and 1020 00:43:03,639 --> 00:43:07,400 so on and convince yourself that this is 1021 00:43:05,440 --> 00:43:08,400 the only combination it's pretty easy to 1022 00:43:07,400 --> 00:43:11,039 convince yourself it's the only 1023 00:43:08,400 --> 00:43:13,318 combination but think a little try to 1024 00:43:11,039 --> 00:43:15,400 get away from point A and see what 1025 00:43:13,318 --> 00:43:17,960 happens I guess the best way to do that 1026 00:43:15,400 --> 00:43:19,559 is just to do experiment meaning move 1027 00:43:17,960 --> 00:43:23,079 parameters of these curves and see how 1028 00:43:19,559 --> 00:43:23,079 equilibrium output changes and so 1029 00:43:24,760 --> 00:43:33,200 on so let's do the first 1030 00:43:28,480 --> 00:43:35,960 experiment and yeah 1031 00:43:33,199 --> 00:43:38,558 maybe so let's let's let's play with 1032 00:43:35,960 --> 00:43:40,599 this so now you have you have your model 1033 00:43:38,559 --> 00:43:42,720 and now we can start asking interesting 1034 00:43:40,599 --> 00:43:45,559 questions the first thing you can ask is 1035 00:43:42,719 --> 00:43:47,399 well fiscal policy how does it 1036 00:43:45,559 --> 00:43:49,480 work 1037 00:43:47,400 --> 00:43:52,200 well 1038 00:43:49,480 --> 00:43:53,838 sorry so here this this is a contraction 1039 00:43:52,199 --> 00:43:56,279 in fiscal policy so the same as we did 1040 00:43:53,838 --> 00:43:57,759 before remember we increase taxes or we 1041 00:43:56,280 --> 00:44:00,960 could have reduced go expenditure 1042 00:43:57,760 --> 00:44:03,079 whatever that would have shifted the we 1043 00:44:00,960 --> 00:44:06,079 we did that when when we look at the we 1044 00:44:03,079 --> 00:44:09,960 did exactly that we shift the to to to 1045 00:44:06,079 --> 00:44:12,160 the left and what happens here is well 1046 00:44:09,960 --> 00:44:14,400 if you shift the to the left there's a 1047 00:44:12,159 --> 00:44:15,879 new combination of output and interest 1048 00:44:14,400 --> 00:44:19,400 rate that is that is consistent with 1049 00:44:15,880 --> 00:44:22,318 equilibrium both markets that's a lower 1050 00:44:19,400 --> 00:44:23,920 output okay so if the FED doesn't do 1051 00:44:22,318 --> 00:44:26,039 anything that means it keeps the LM 1052 00:44:23,920 --> 00:44:28,280 there and there's a contractionary 1053 00:44:26,039 --> 00:44:30,558 fiscal policy well that will lead to 1054 00:44:28,280 --> 00:44:32,519 contraction in output as well that's the 1055 00:44:30,559 --> 00:44:34,640 reason we call it contraction not only 1056 00:44:32,519 --> 00:44:37,920 because fiscal not not only because 1057 00:44:34,639 --> 00:44:39,719 govern expenditure decline but it's if 1058 00:44:37,920 --> 00:44:42,318 taxes increase that's contractionary 1059 00:44:39,719 --> 00:44:46,558 because it reduces aggregate demand and 1060 00:44:42,318 --> 00:44:46,558 the equilibrium that will reduce output 1061 00:44:47,960 --> 00:44:54,440 okay so that's canonical contractionary 1062 00:44:51,760 --> 00:44:56,359 fiscal policy you move output to the 1063 00:44:54,440 --> 00:44:59,559 left interest rate doesn't move because 1064 00:44:56,358 --> 00:45:03,719 that's controlled by the FED but but 1065 00:44:59,559 --> 00:45:05,800 output declines okay so if somebody ask 1066 00:45:03,719 --> 00:45:08,598 you what happens if if if there's a 1067 00:45:05,800 --> 00:45:11,039 fiscal contraction you were asking a bit 1068 00:45:08,599 --> 00:45:13,440 the the opposite side you know that 1069 00:45:11,039 --> 00:45:15,679 people may have spent we have perhaps a 1070 00:45:13,440 --> 00:45:17,960 fiscal expansion that was very large but 1071 00:45:15,679 --> 00:45:20,000 what happens with a fiscal contraction 1072 00:45:17,960 --> 00:45:23,039 well that will lead to lower equilibrium 1073 00:45:20,000 --> 00:45:25,719 output I keep pring the lower equ what 1074 00:45:23,039 --> 00:45:27,759 happens if you have a very large fiscal 1075 00:45:25,719 --> 00:45:29,279 expansion what what happens if you have 1076 00:45:27,760 --> 00:45:32,319 a very large fysical 1077 00:45:29,280 --> 00:45:34,240 expansion what moves Ah that's something 1078 00:45:32,318 --> 00:45:36,558 that's you should that's a question you 1079 00:45:34,239 --> 00:45:38,078 should always ask yourself when when 1080 00:45:36,559 --> 00:45:42,160 there is any question 1081 00:45:38,079 --> 00:45:46,318 islm of islm you should ask which curve 1082 00:45:42,159 --> 00:45:48,920 moves start from that always okay so if 1083 00:45:46,318 --> 00:45:50,800 if we ask you any question about that is 1084 00:45:48,920 --> 00:45:53,159 obvious about aslm the first thing you 1085 00:45:50,800 --> 00:45:55,200 should ask is which Curve will 1086 00:45:53,159 --> 00:45:58,759 move 1087 00:45:55,199 --> 00:46:01,759 so suppose I tell you 1088 00:45:58,760 --> 00:46:05,599 um due to covid the covid shock there 1089 00:46:01,760 --> 00:46:09,800 was a massive ER transfer 1090 00:46:05,599 --> 00:46:11,280 income transfer to lowincome individuals 1091 00:46:09,800 --> 00:46:12,318 that is we had a very expansionary 1092 00:46:11,280 --> 00:46:14,640 fiscal 1093 00:46:12,318 --> 00:46:17,199 policy first thing you should ask is 1094 00:46:14,639 --> 00:46:19,239 okay which curve moves the LM or the is 1095 00:46:17,199 --> 00:46:23,558 if I do 1096 00:46:19,239 --> 00:46:25,679 that is the is shift to the right does 1097 00:46:23,559 --> 00:46:27,760 the LM move no has nothing to do with 1098 00:46:25,679 --> 00:46:29,358 monetary policy 1099 00:46:27,760 --> 00:46:31,400 okay so that's the first thing you need 1100 00:46:29,358 --> 00:46:33,920 to do which curve is 1101 00:46:31,400 --> 00:46:36,680 moving okay if it is fiscal that's a 1102 00:46:33,920 --> 00:46:41,159 Goods Market thing that means it's going 1103 00:46:36,679 --> 00:46:41,159 to move the yes not the 1104 00:46:43,519 --> 00:46:49,759 LM what is the mechanism here what 1105 00:46:48,000 --> 00:46:53,599 happened 1106 00:46:49,760 --> 00:46:55,400 well remember what we have is I told you 1107 00:46:53,599 --> 00:46:57,160 go always back to this diagram if you 1108 00:46:55,400 --> 00:46:58,400 increase taxes and you keep keep the 1109 00:46:57,159 --> 00:46:59,960 interest rate constant and you start 1110 00:46:58,400 --> 00:47:03,000 from there so so the interest rate 1111 00:46:59,960 --> 00:47:05,000 doesn't move then that will do what what 1112 00:47:03,000 --> 00:47:06,960 increasing taxes did in lecture three 1113 00:47:05,000 --> 00:47:10,000 will reduce aggregate demand and then 1114 00:47:06,960 --> 00:47:12,240 the multiplier will take us to a larger 1115 00:47:10,000 --> 00:47:14,480 decline that the initial fiscal 1116 00:47:12,239 --> 00:47:19,039 contraction okay and that's a decline in 1117 00:47:14,480 --> 00:47:22,679 equilibrium output so that y1 there is 1118 00:47:19,039 --> 00:47:26,318 exactly a this one 1119 00:47:22,679 --> 00:47:27,719 here that y Prime okay I haven't moved 1120 00:47:26,318 --> 00:47:30,239 the interest rate I kept it at the same 1121 00:47:27,719 --> 00:47:32,239 level I had a fysical 1122 00:47:30,239 --> 00:47:36,358 contraction that's what we describe with 1123 00:47:32,239 --> 00:47:37,399 that diagram well that's my new is I 1124 00:47:36,358 --> 00:47:40,279 have a new 1125 00:47:37,400 --> 00:47:44,318 is because for any for the same interest 1126 00:47:40,280 --> 00:47:46,000 rate I have a lower equilibrium output 1127 00:47:44,318 --> 00:47:48,159 and it happens that the FED DM change 1128 00:47:46,000 --> 00:47:49,599 the interest rate so that's going to be 1129 00:47:48,159 --> 00:47:51,480 my equilibrium output the whole curve 1130 00:47:49,599 --> 00:47:54,200 moved to the left that would could tell 1131 00:47:51,480 --> 00:47:56,079 three slides ago but now I know more I 1132 00:47:54,199 --> 00:47:57,960 also know that since the FED hasn't 1133 00:47:56,079 --> 00:48:01,039 reacted I I know exactly what is the new 1134 00:47:57,960 --> 00:48:02,480 equilibrium output which is this I don't 1135 00:48:01,039 --> 00:48:04,880 before we could only tell that the curve 1136 00:48:02,480 --> 00:48:07,440 has shift to the left now since the fan 1137 00:48:04,880 --> 00:48:09,440 react to that fiscal contraction I also 1138 00:48:07,440 --> 00:48:14,000 know the equilibrium output will end up 1139 00:48:09,440 --> 00:48:15,960 at White Prim okay good so I'm want to 1140 00:48:14,000 --> 00:48:17,159 stop here and and and in the next 1141 00:48:15,960 --> 00:48:21,400 lecture we'll 1142 00:48:17,159 --> 00:48:21,399 continue with this