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46:12
Transcript
0:16
the main topic in this part is really
0:19
open economy and uh so we extended the
0:22
eslm mo uh we did not bring in we we
0:27
again shut down price changes so we said
0:29
uh pric is completely fixed no Philips
0:32
curve here so we expanded the eslm model
0:36
to add this open E economy Dimension and
0:40
so we start from the same aggregate
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0:42
demand function that we had in close
0:44
economy consumption plus investment plus
0:47
government expenditure but now we have
0:48
to draw a distinction between Demand by
0:51
domestic households companies and the
0:54
government and the demand for
0:56
domestically produced goods and so Z is
0:59
the demand domestically produced Goods
1:01
which is equal to demand plus the demand
1:03
that foreigners have for the goods
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1:05
produces at home minus the Imports that
1:09
part of that expenditure that is going
1:10
to Imports that means Goods produced by
1:12
other
1:14
countries um so the new behavioral
1:16
functions here where the export function
1:18
and the import function uh export is
1:22
increasing in foreign output more income
1:24
abroad will lead to more Imports by them
1:27
which means more export for home home
1:30
and the it's decreasing on with respect
1:33
to the exchange rate real exchange rate
1:35
and nominal exchange rate will be the
1:36
same here since we have fully sticky
1:38
prices but
1:40
H if if the real exchange it appreciat
1:43
that means domestic goods are more
1:45
expensive it means exports are less
1:47
foreigners are going to buy less of our
1:49
Goods conversely for imports is like the
1:52
exports of the other country means that
1:54
if domestic output goes up then then
1:57
there will be more purchases of foreign
1:59
foreign er er goods and if the exchange
2:03
is appreciate means also that foreign
2:04
goods are cheaper for us and therefore
2:06
we import more okay so positive so those
2:10
were those were the two new behavioral
2:12
functions in the in the Goods Market
2:14
expanded to include an open economy and
2:16
that had implications for the diagram
2:18
that we had in lecture three or so to
2:22
determine equilibrium output ER you know
2:24
we started from the same demand we had
2:27
in close economy then we had to subtract
2:29
in
2:30
in import and uh and that is shift
2:34
things down because we are now as part
2:36
of the domestic demand that is going to
2:38
foreign Goods not to domestic Goods but
2:42
ER it's also rotates a curve because the
2:45
higher is domestic income the more are
2:47
the Imports uh that we do from the rest
2:50
of the world now to that we have to add
2:53
the export which are not a function of
2:55
domestic output that's that's a parallel
2:56
shift with respect to this curve no we
2:59
go up up and and that gives us the ZZ
3:03
curve which is what we call the demand
3:06
for domestic Le domestically produced
3:09
Goods now notice that the distance
3:11
between the demand for domestically
3:13
produced goods and the domestic demand
3:16
for goods is what is the net export so
3:19
the distance between z z and the D is
3:21
the net export so in this point here for
3:26
example ZZ is higher than DD which means
3:29
that our exports are greater than our
3:31
Imports and that's the reason you have a
3:33
trade surplus at this point they're the
3:35
same and that's the reason the trade
3:37
account is balance and but over here
3:40
Imports exceed exports and that's the
3:42
reason we have a trade deficit
3:45
okay I'm going to go very quickly so you
3:47
you're in charge of stopping me I'm not
3:49
going to ask you question just stop me
3:50
if there's something that you need
3:52
clarifications okay for so that's what
3:54
the demand for domestically produced
3:56
Goods now we're going to determine
3:58
equilibrium output in this open e e omic
4:00
context and that means you know
4:01
aggregate demand has to be equal
4:03
aggregate demand for domestically
4:05
produced good has to be equal to output
4:08
and that's what we do with the 45 degree
4:10
line here and so where the 45 degree
4:13
line intersect with this ZZ curve that's
4:14
our equilibrium output now it happens
4:18
that in this example that leads to a
4:19
trade deficit but there's nothing here
4:22
so we still determine equili output up
4:24
here and then we read in this curve
4:27
bottom curve what is implication for the
4:29
traes deficit or Surplus
4:32
okay H but the equilibrium condition
4:34
important is that output domestically
4:37
produc output has to be equal to the
4:39
demand for domestically produced Goods
4:42
not for total demand it's Dem demand for
4:44
domestically produced Goods okay because
4:46
this is a can model in which output is
4:49
aggregate demand determined but it has
4:50
to be aggregate demand for the things
4:52
you're producing not AG demand for all
4:55
Goods around the world okay good so then
4:59
we did some experiments we said well
5:02
suppose what happens in this open
5:03
economy context if we increase
5:05
government expenditure well the curent
5:08
will shift up in exactly the same way as
5:12
as in the close economy the difference
5:14
will be in the multiplier though because
5:17
as output goes up as a result of the
5:19
expansionary aggregate demand that also
5:21
means that domestic income will go up
5:24
and and that means that Imports will go
5:26
up and that's demand that will go for
5:27
foreign goods and that's the reason the
5:29
z z curve has a lower multiplier it's
5:32
flatter than the DD curve okay still if
5:36
we start for example with a trade
5:38
balance since Imports are going to
5:39
increase as a result of this
5:41
expansionary fiscal policy we going end
5:43
up with a trade deficit and that's the
5:46
reason the response of output is less
5:48
than close economies because part of
5:50
that goes to foreign Goods conversely if
5:53
this other country that is doing a
5:55
expansion in fiscal policy or something
5:56
that leads to higher output abroad wi
5:58
star that's also expansionary for home
6:01
because exports the export function goes
6:03
up no and that leads to an increase in
6:06
output ER still with lower multiplier
6:09
because part of that increase in
6:10
domestic output will go will go to
6:13
Imports but the in this case unlike the
6:16
other ones actually the current the the
6:18
trade balance improves because it's been
6:20
pulled by exports and so we at at impact
6:23
we get a big increase in export which is
6:26
the driver of increasable demand for
6:28
domestically produced Goods and then as
6:30
income goes up we undo some of that but
6:32
you end up with sort of higher high
6:34
higher better trade deficit better trade
6:37
surpluses than than in the case in which
6:40
you induce the the expansion in agre
6:45
demand uh then the last step there was H
6:48
to look at the role of the exchange rate
6:51
and uh where we said is we're going to
6:53
make some assumptions that I promise you
6:55
and and I now read the quiz so I I I I
6:59
guarantee you I honor This Promise H
7:02
nothing weird will happen meaning if if
7:04
our Goods gets more expensive that means
7:07
that net exports will be worse and and
7:11
if if H for two reasons for at least for
7:14
at least one reason but it could be too
7:16
if if if the exchange rate goes up then
7:19
there's going to be less exports at any
7:20
given level of foreign income that will
7:23
worsen the net export and then we were
7:27
going to tend to import more now that
7:28
will be parti should upset for the fact
7:30
that you can buy more with the same
7:31
amount of dollars H but we said we're
7:34
going to impose conditions such that the
7:36
positive the negative effect of an
7:38
appreciation on that export always
7:40
dominates and again in your quiz you're
7:42
going to have a situation like that and
7:44
that will be the
7:47
case so don't think that that we're
7:50
trying to trick you anything this will
7:52
hold okay the the point of this being
7:56
that you know that that uh
8:00
depreciating your
8:02
currency you know making your goods less
8:06
expensive ER is equivalent to will
8:09
produce an a response equivalent to what
8:11
you get here out of an increasing y star
8:14
no because that's export will go
8:18
up and you're going to get all the shift
8:22
net export function will go up that will
8:24
increase aggregate demand and so on so
8:26
that's kind things that countries want
8:28
to typically when they're in a recession
8:30
and so on then that was an introduction
8:35
to the most important lecture in this
8:38
part of
8:39
the course which is the Mandel flaming
8:42
model and I I I promise you that you
8:47
would get 70% at least in the quiz and I
8:50
already read the quiz so I tell you
8:52
there is at least 70% of your points
8:54
have to do with this model so you better
8:57
understand it very well you do every
8:58
single comparative Statics that you can
9:00
imagine with this Mo and then you'll get
9:02
70% at least I think you get 73 actually
9:05
but but but that's
9:08
the so what's this well the Mandel
9:12
flaming model is simply what I just
9:14
showed you is the good market
9:15
equilibrium no that's the but with an
9:20
endogenous exchange rate and uh so we we
9:25
rewrote to say since we're assuming
9:26
compettive sticky prices we can replace
9:28
the real Exchange by the nominal
9:29
exchange rate H but now we're going to
9:33
endogenize the exchange rate and and and
9:36
for that we're going to use the uncover
9:38
in parity condition this a condition you
9:40
should understand very well as well okay
9:43
so that tells you essentially that the
9:46
expected Return of the two bonds the
9:49
bonds issuing foreign currency and
9:51
domestic currency have to be the same
9:53
the Spector return have to be the same
9:55
okay and this condition ensures that
9:58
because if a country for example example
10:00
if the domestic interest rate is higher
10:02
than the international interest rate you
10:04
need to expect a depreciation of the
10:06
current currency otherwise the expected
10:09
return would not be the same okay and
10:12
that's the reason when we add the
10:14
assumption that the Spector exchanges is
10:17
fixed at least temporarily H then an
10:21
increase in the interest rate leads to
10:22
an appreciation of the exchange rate why
10:24
because that if the exchange rate
10:26
appreciate but the expected exchange
10:28
rate stays put that that means the
10:29
expected appreciation will have to be
10:31
undone and that means that leads to
10:33
unexpected depreciation okay so that's
10:36
very important okay so here you have
10:38
therefore you need to understand this
10:40
know that forgiv expectation of the
10:43
exchange rate and increasing domestic
10:45
interest rate appreciates the domestic
10:47
currency and and increasing the foreign
10:49
interest rate without us matching it
10:52
will lead to a depreciation of the
10:54
current of of the domestic currency okay
10:57
so that's what you have there that's
10:59
important
11:01
important now notice that if the
11:03
expected exchange rate goes
11:06
up and the interest rates do not change
11:09
then the current exchanger has to go up
11:12
because if it didn't then you would have
11:14
an expected capital gain out of the
11:16
currency and expected appreciation and
11:18
that would add to the expected return of
11:21
own owning a domestic bones okay
11:26
good so we characterize that interest
11:29
parity condition as follows we said well
11:31
look this this here we're plotting the
11:34
domestic interest rate here we're
11:36
putting the current exchange rate and
11:38
what we're marking in this picture this
11:40
is the curve that traces the uip the and
11:43
cover by the condition and naturally
11:45
when the domestic interest rate is equal
11:47
to International interest rate then it
11:49
has to be the case that the exchange
11:51
rate is at the same level as the
11:52
expected exchange no if that is equal to
11:55
that so if we're here then we know that
11:58
a point in that curve is that in which
12:00
the exchange rate is equal to the
12:02
expected exchange rate okay that's what
12:05
we have
12:08
yeah good so you should understand this
12:11
curve and and know what moves it here
12:13
it's very clear what moves it no if
12:15
there are two things that can move this
12:16
this curve here one is a change in I
12:19
star the other one is a change in
12:20
expected exchange rate if what happens
12:24
if the is star goes
12:27
up well you know that the new new the
12:29
uip will shift but you do know that the
12:34
next the The Point equivalent to that
12:36
that is one in which exchange rate is
12:38
equal to expected exchange rate we have
12:40
to have a higher interest rate domestic
12:41
interest rate no because if I'm bringing
12:44
this up and I want to still look at the
12:46
point in which e is equal to expected
12:48
exchange rate then I have to move I up
12:51
by the same amount and so I know that
12:53
this curve when when is Star goes up
12:55
this curve moves up or to the left you
12:57
pick which way you analyze
13:00
okay now what about the expected
13:02
exchange rate well if the expected
13:04
exchange rate goes
13:06
up if the spected exchange goes up and
13:09
the international interest hasn't gone
13:11
up H so if this moves to to the spected
13:15
exchanger moves to the right then and
13:17
the and the and the domestic interest
13:21
doesn't go up then that means that the
13:24
current exchanger will have to also go
13:27
up okay so that means H if this goes up
13:32
then at an interest rate equal to the
13:34
the international interest rate so let's
13:36
tra look in this direction then we have
13:38
a point around here okay if if that
13:43
wasn't the cas case then you would
13:45
respecting an appreciation and then
13:46
again would be inconsistent with
13:50
h the uip then we put things together so
13:54
what we did is we replace we use the uip
13:57
to replace exchange rate there and now
13:59
we get this expression in the net export
14:02
function now we the LM is exactly the
14:04
same as before we we have
14:07
a the Central Bank sets the interest
14:10
rate here I'm writing it in terms of the
14:12
nominal interest rate I think in the
14:14
quiz we wrote it in terms of the real
14:16
interest rate but it's the same because
14:17
prices is equal to are fixed so real and
14:20
nominal interest rate are exactly the
14:21
same
14:23
yeah is the xais the expected exchange
14:27
rate no is the actual exchange rate the
14:30
spected exchange rate is in this curve
14:32
here that is a parameter okay this
14:36
happens to be a value of the current
14:37
exchange equal to the spected exchange
14:39
rate which is convenient to plot because
14:41
that's also when the domestic interest
14:42
rate which is what I'm putting here is
14:44
equal to International interest rate
14:46
that's all that I'm saying and then if
14:47
you shift this to the
14:51
right exchange rate up the expect exate
14:55
up then I know that a new point in this
14:57
curve has to have a higher current
15:00
exchange rate so that I know I know that
15:02
the equivalent to this point a is going
15:04
to be to the right if you lower the
15:05
foreign interest rate then what I know
15:08
is that exactly that that the point at
15:13
which exchange it is equal to expected
15:14
exchange rate has to have a lower
15:17
domestic interest rate so that means
15:19
that I know that that that this point a
15:22
will be around here which is like a
15:24
shift to the right okay
15:31
anyway so so as I said I was saying ER
15:35
nominal real interest are the same I
15:37
think in the in the quiz we wrote are
15:39
there but it's the same same
15:42
more so now you see that interest rate
15:44
have two effects no h one is the
15:47
traditional effect affects investment
15:49
but it also affects exchange R so H an
15:52
increas in the domestic interest rate
15:54
now will will be doubly contractional in
15:56
the sense that we lower domestic
15:58
investment that reduces aggregate demand
16:00
but at the same time it will also
16:03
appreciate the exchange rate and
16:04
therefore it will reduce net exports
16:06
okay we're going to import more and
16:08
Export less and that's also going to
16:10
reduce aggregate demand so that's that's
16:13
the those are the two effects so that's
16:15
the contribution of the all this
16:17
exchange rate block to our islm
16:20
framework Mandel flaming is simply islm
16:23
plus a a you know a uip condition and a
16:26
net export function that's it
16:30
so we put out now the two things
16:32
together sort of a standard is islm now
16:35
with different slope and so on because
16:37
we have this net export function and we
16:38
have more parameter we have y star is
16:42
star and things like that and then we
16:43
have the uip there and then then we did
16:46
a few experiments no said suppose that
16:49
now you have an expansionary monetary
16:51
policy okay so an expansion in monetary
16:56
policy as before with a slightly
16:58
different slopes and so on because of
17:00
the net export function will lower
17:02
equilibrium output and it will lower it
17:04
for two reasons as I said before will
17:05
lower it because investment will decline
17:08
but also because higher interest rate
17:10
means an appreciation of the exchange
17:12
rate
17:13
today because you have to expect a
17:15
depreciation now in the next period and
17:17
and that that means also less net
17:20
exports okay so interest rate is
17:22
contractionary for for two different
17:24
reasons here is that clear
17:29
yeah raise interest
17:33
rate raise interest rate will lower
17:35
aggregate demand for the standard reason
17:37
but on top of that we're going to get an
17:39
appreciation of the exchange rate which
17:41
also reduces net exports
17:45
okay what about an increase in go
17:47
expenditure well H it's the same as
17:50
before and nothing changes relative to
17:52
before except for the fact that we have
17:54
a lower multiplier but it's still the
17:56
case that is expansionary but it doesn't
17:58
affect the interest rate it doesn't
17:59
affect the exchange rate or anything
18:01
like that again it's less expansionary
18:04
than in closed economy because part of
18:05
that energy will go to
18:08
inputs then I went to this diagram and
18:11
and I play with this uh diagram here I
18:15
said well suppose that the expected
18:17
exchanger goes up then what which curves
18:21
change and the first one that changes is
18:24
this one no this one moves to the right
18:26
so you get an appreciation today and
18:28
that also means that this curve here the
18:30
yes will shift to the left okay if the
18:33
spected exchanger goes up and you don't
18:36
change monetary policy that means
18:37
interest rate will go
18:39
up sorry and you don't change monetary
18:41
policy that means the current exchanger
18:43
will appreciate that will reduce net
18:45
export and and that's a shift in this
18:47
space as a shift in the yes to the left
18:50
okay this is a parameter these two
18:53
things are parameters now in the ls
18:55
diagram okay what about for an output uh
18:58
going down well that doesn't affect the
19:00
uip condition but it does affect net
19:03
export so that moves I to the left okay
19:07
and the last thing we did was an
19:10
increase in in in isar and an increase
19:13
in isar what does is know is that at the
19:16
same interest rate then you know that
19:18
you need a depreciation of the currency
19:19
today because that will lead to an
19:21
apprec expected appreciation so that
19:23
means that this uip PE curve moves to
19:25
the left and the is curve
19:29
moves to the right that's an increase in
19:32
the interest rate taken as given for an
19:34
output okay if for an output also
19:36
changes then you have to look at the
19:38
combination of the two things okay but
19:41
um but taking for an output as given
19:44
then this Curve will shift to the left
19:46
and that will move the to the right
19:48
because the exchanger will
19:52
depreciate you said sometimes countries
19:54
choose to fix exchange rates and when
19:56
you fix an exchange rate well and if
19:58
it's credible exchange rate then the
20:00
spected exchange rate equal to the
20:02
actual exchange rate equal to some
20:03
constant then that implies immediately
20:06
that the domestic interest rate has to
20:07
be equal to International interest rate
20:10
okay so that if you fix your exchange
20:12
rate to someone else then you give up
20:13
your monetary policy the monetary policy
20:15
is run by a different country
20:19
okay okay good okay so that's a very
20:22
important lecture play with it please
20:25
well we then we look more carefully at
20:28
at at
20:30
uh at different exchanger
20:32
regimes ER and and the effectiveness of
20:36
policy within each of this regime the
20:39
flexible exchange rate system which is
20:40
the one we were discussing before H you
20:43
get sort of you know if a country is in
20:46
a recession you can use fiscal policy I
20:48
showed you that before it works well ER
20:50
and you can also use expansionary
20:52
monetary policy which will be very
20:54
successful for two reasons one the
20:56
traditional one but the second reason is
20:58
that it will depreciate your currency
21:01
okay good now then we say suppose that
21:04
you have a country that that is also in
21:06
a recession but you have a a fixed
21:08
exchange rate well then you still can
21:10
use fiscal policy there's nothing
21:12
against that but but you cannot use the
21:14
expansion in monetary policy okay so
21:17
that's a limitation of fixed exchang
21:18
that you lose an important
21:22
tool another problem that can arise with
21:25
fix fixable exch fixed exchange rates is
21:28
is speculative attacks on the currency
21:30
sometimes the peg is not credible and
21:33
when the peg is not credible you can
21:35
imagine that you know that suppose that
21:37
people expect your currency to
21:41
depreciate depreciate so expected
21:43
exchanger goes down and and suppose that
21:46
you do want to keep your peg today
21:49
that's what typically happens somebody
21:50
speculates against your P But Central
21:52
Bank resist that for a while but the
21:55
only way it can resist that short of
21:57
closing the capital account and doing
21:59
all sort of things there but you haven't
22:03
learned about those so don't worry H the
22:05
only tool you have here to defend a
22:07
speculative attack on your currency that
22:09
is for the exchange not to depreciate
22:10
today is by raising interest rate so the
22:13
defense of an exchange rate causes a
22:14
recession at
22:16
home that's another problem that
22:18
flexible exchange rate
22:20
have and and there are sort of the deal
22:22
seems pretty obvious that you don't want
22:24
to have a fixed exchange rate and I said
22:26
well be careful because flexible
22:28
exchange rate are also not a panasa you
22:30
may get lots of volatility in the
22:31
exchange rate because the role of
22:33
expectations is sort of is is very
22:37
important um anyways this looks
22:40
complicated but it's essentially what we
22:42
did later on when we price equity and
22:43
things like that we use sort of the same
22:45
sort of iterated substitutions of things
22:48
this was just meant to say that in a
22:50
flexible exchange rate really and if
22:53
once you endogenize Spector exchange you
22:55
don't take it as a constant it gets to
22:56
be very complicated because effectively
22:58
The Exchange is spin down by the
23:00
expectations of infinite Horizon of
23:03
interest rate at home and abroad so so
23:05
there's lots of space for creativity and
23:07
moving things around and that's the
23:09
reason exchanges can be very
23:14
volatile okay good so anyway so all that
23:17
that was it for ER Mandel flaming plus
23:21
okay any question about that because now
23:23
I'm going to move to the next part okay
23:26
so then then uh The Next Step uh was to
23:28
look at the asset prices really and or
23:31
valuations of Assets in general that
23:34
that have cash flows in the future or or
23:38
or and exchange it's a little bit like
23:40
that by the way but we talk a lot about
23:43
current
23:44
events but the key thing was this no we
23:48
said okay you know many
23:51
things ER many Financial or real assets
23:55
actually or even your human wealth we
23:57
discuss later on
23:59
you know you you you you you you are
24:01
receiving some income today but you're
24:02
also expecting to receive income in the
24:04
future and this part was about how do we
24:07
value those things that we receive in
24:08
the future those cash flows that come in
24:10
the future and so we developed this
24:12
concept
24:13
of expected present discounted value and
24:16
we said well very natural way of
24:18
bringing dollars receiving the future to
24:20
the present is to discount them by the
24:23
interest rate between now and then okay
24:26
and and the reason the logic behind that
24:28
is because if you give me a dollar today
24:30
I can do a lot more than if you give me
24:32
a dollar five years from now because I
24:34
can invest the dollar today and earn the
24:36
interest rate return up to five years
24:38
from now so a dollar today is worth a
24:40
lot more than five years a dollar five
24:42
years from now therefore a dollar five
24:45
years from now is worth a lot less than
24:46
a dollar today how much less one over
24:49
one plus the interest rate over that
24:50
period which is
24:53
okay so that's what we did then I show
24:55
you sort of a general a general cash
24:58
flow this is an asset that gives a cash
25:00
flow ZT at the beginning of this period
25:03
ZT plus one at the beginning of the next
25:04
one or at the end of this one something
25:07
like that well this one you don't need
25:09
to Discount that one you do need to
25:10
Discount because you're not receiving it
25:12
now you're receiving it a year from now
25:14
this when you need it's two years from
25:15
now you need to discount it more because
25:17
you know it's two years that you could
25:19
be earning interest rate and so on so
25:21
forth okay this formula you need to
25:27
understand uh and I said well that's if
25:29
you know the future if you don't know
25:31
the future then you just replace the
25:33
things you don't know for the respected
25:35
value that's what and that's the
25:36
approximation in real I mean if you were
25:38
to do this formally it's a little more
25:41
complicated but for this course that's
25:43
all that you do
25:46
okay and then I look at some particular
25:48
cases this this is a case the same case
25:52
but in one in which the interest rate is
25:53
constant suppose that you expect the
25:55
interest rate to be constant then is a
25:57
little simpler expression because rather
25:58
than getting these products of one plus
26:01
one the interest rates at different
26:03
times H you get just powers of one plus
26:06
I then another one that is simpler
26:08
obviously is one in which all these
26:10
expected payments are constant and so on
26:13
and then even simpler if you spec if the
26:16
con if the interest rate is constant and
26:18
the payment is constant H you get some
26:21
simple formulas like that simpler
26:23
formulas and then cases in which asset
26:26
lives forever of that kind then that's
26:28
value if you don't pay for if you don't
26:31
receive the the First Cash Flow now but
26:32
you receive it at the beginning of next
26:34
year or at the end of this one then it
26:35
gets even simpler like that and I you're
26:38
going to get a question of this kind
26:40
okay and which you're going to be asked
26:42
to compare two different assets that
26:45
have a different profiles of cash flows
26:49
and you're going to have to compare
26:50
between those two okay then we talk
26:53
about bonds and bond yields and
26:56
essentially we use expected present
26:57
discounted value formula just for bonds
27:00
and bonds bonds have a very particular
27:02
form profile of payment typically some
27:04
coupons and some final payment which is
27:07
we call it the face value of the bond or
27:09
something like that and we said a very
27:12
important Concept in bonds is
27:14
maturity maturity is the date or the
27:17
number of years till the last payment on
27:20
that Bond okay doesn't matter whether
27:22
you receive lots of little coupons along
27:24
the way and one final payment whether
27:26
you receive no payment what whatever
27:28
until the last date that doesn't matter
27:31
the maturity of a bond is the date the
27:34
number of years till the last time you
27:36
your last payment
27:38
okay so we give some examples there a
27:41
bond that pays nothing now but pays 101
27:43
year from now ER has a has a price is a
27:47
pres is discounted value of 100 no one
27:50
year divided by one plus the one year
27:52
interest rate at time
27:54
T um a bond that pays nothing up to two
27:57
years and then in the second at the end
28:00
then after two years pays $100 then
28:03
that's a value the price of that bond
28:05
which is 100 discounted by that
28:09
okay H then we look at Arbitrage which
28:11
is says suppose that you you hold a bond
28:15
that that you're considering
28:17
investing your money for one year but
28:20
you have two options one is to buy a
28:21
one-year Bond the alternative is to buy
28:24
a two-year Bond now and sell it at the
28:25
end of the year those two strategies
28:27
should would give you more or less the
28:29
same return H well you know if you if
28:32
you buy a one-year Bond you're going to
28:34
get 1 plus i1t at the end of the year if
28:37
you go through the two-year Bond
28:40
strategy then H you're going to pay this
28:43
today but you're going to you're going
28:45
to H ER rece expect you expect to
28:48
receive the price of a oneyear bond one
28:51
year from now and we said these two
28:53
things have to be equal more or less
28:56
equal I mean again we're not adding risk
28:59
to these things H if there's no risk
29:01
consideration of agents at risk neutral
29:03
then these two things have to be equal H
29:06
that allows you to solve for the price
29:08
of a two-year Bond as expected price of
29:10
a oneyear bond one year from now divided
29:12
by one plus the interest rate but the
29:14
expected price of one year bond one year
29:17
from now is going to be like a oneyear
29:19
bond but one year from now so it's 100
29:22
divided 1 + i1 t + 1 expected value I
29:26
can stick that in there and I get EX the
29:28
same expression okay so these are two
29:30
different ways of pricing a
29:33
bond or any other asset by
29:38
actually and then we Define the yield to
29:40
maturity so that's an important
29:43
concept yield to
29:46
maturity is is is is a is a rate that is
29:51
a constant
29:53
rate that gives you Thea exactly the
29:57
same
29:58
that gives you the current price of the
30:00
bond okay so we already determined the
30:03
the price of a two-year bond is that
30:07
okay and now I'm saying well suppose
30:10
that let me look for a rate that is the
30:12
same in both
30:14
periods that gives me the same price and
30:17
that's that's the reason I have a
30:18
subscript two here at time T so what is
30:21
the rate that if I put a constant rate
30:25
so I have 1 + I2 T * 1 +
30:29
i2t gives me exactly the same price as
30:33
the one we already determined okay and
30:36
that's what we call the yield to
30:37
maturity or the yield or or the end in
30:40
this case would be a two-year rate if
30:41
you hear what is a two-year rate is that
30:45
okay H so so we know what this price is
30:49
which is equal to that that's this
30:51
expression there so the whole trick here
30:53
is to find the 2-year rate at time T
30:57
that that gives exactly the same value
30:59
that means obviously since 100 is equal
31:01
to 100 it means to find the i2t that
31:03
gives you this equal to that which would
31:07
say is approximate implies that
31:08
approximately the twoyear rate is like
31:10
an average of the two rate of the two
31:12
onee rates okay but this concept you
31:16
should know what it
31:18
is I said there are two forms of risk in
31:21
a bond there one one type of risk is the
31:23
fall risk what if the issuer of the bond
31:26
doesn't pay you now there's a huge issue
31:27
with the US you know Deb ceiling because
31:30
if they somehow they don't fix that
31:32
there will be a default on some treasury
31:34
bonds let's hope that it doesn't happen
31:36
but but but that's theault risk is that
31:39
whoever issued the debt at the time in
31:42
which he should be paying you a coupon
31:43
or or the principal the face value it
31:47
doesn't pay you that's the fall risk
31:49
okay and and and typically US Treasury
31:52
bonds don't have the risk so nobody
31:55
worries about that at this moment
31:58
the default risk price in US bonds for
32:01
one month bonds is higher than that of
32:03
Mexico the bonds in Mexico or Brazil
32:07
that tells you that the kind of things
32:09
we have but in any EV so so this is a
32:13
temporary default risk I mean nobody
32:16
expects in the US that this will not be
32:17
eventually repaid but you can cause a
32:20
big
32:20
mess by just ER delaying a a coupon
32:24
payment I mean when when when these
32:26
coupons are huge no
32:28
and so so that's what's leading to all
32:31
this concern but but in any
32:33
EV that's one type of risk but we didn't
32:36
look at that type of risk a lot the
32:37
corporate bonds have a lot of that risk
32:39
but we didn't look at that kind of risk
32:41
we look at the another kind of risk
32:42
which is price risk no if you have a one
32:45
you invest in your oneyear bond there no
32:47
price risk you're going to get your
32:49
coupon your face value of 100 at the end
32:51
of the year that's it if you go through
32:52
a two-year strategy there's a risk there
32:54
because you don't know exactly what the
32:56
price of the two oneyear Bond will will
32:58
be one year from now and there's a risk
33:00
there we are not looking at what risk
33:03
Avers cons investors do and so on but in
33:06
reality there is such a risk okay and
33:09
just the way we mold that is we said
33:11
well then if I'm going to go through two
33:13
years through a two-year bone route for
33:16
a one-year investment then I don't have
33:19
to H set this equal to the return I get
33:23
in the sh Bond the oneyear bond I have
33:25
to add an extra risk premium and then
33:27
where right to this formula using the
33:29
same steps we said well the one the the
33:32
the two-year rate is really the average
33:34
of the one expected onee rates plus a a
33:37
premium and we call that actually the
33:39
term
33:40
premium you're more likely to face a
33:42
question about the top of this slide and
33:44
the bottom of the slide but I don't
33:45
remember
33:48
fully
33:50
ER stock prices and Present Value well
33:53
it's the same sort of idea know the only
33:55
difference is
33:56
that that that uh equities do not have
34:02
maturity stocks do not have maturity in
34:04
principle a company would last forever
34:07
and and and so there's no there's no
34:10
maturity and there is also the
34:12
commitment of the coupons are a lot
34:15
shakier in the sense that you know yeah
34:17
compan is likely to give dividends they
34:19
may announce a dividend policy but it's
34:20
not a
34:21
commitment if you know Regional Banks
34:24
now are not giving any dividend because
34:26
they want to preserve the capital okay
34:28
they could but they're not because they
34:30
want to build Capital just to be more
34:32
resilient
34:34
to any fly bad news okay but anyway so
34:38
Equity that that means that you always
34:40
have this future price floating around
34:42
and you can keep substituting this
34:44
multiple times and essentially you get
34:46
to an expression that says look the the
34:49
price of equity is really this the
34:51
spected present discounted value of the
34:54
dividends H and that includes lots of
34:57
uncertainty because because you don't
34:57
know exactly where the interest rate
34:59
will be in that period and so on and
35:01
there's always a a a remaining term out
35:03
there which also causes a lot of trouble
35:06
in practice
35:08
assets equities move a lot more than
35:12
than what you can justify with the
35:13
Spector present value of
35:16
dividends there's a lot of
35:18
volatility ER there are bubbles and all
35:20
sort of things I told you the story of
35:25
Newton and and so on so so this formula
35:28
for the bonds those formulas are great
35:31
for Equity you're going to be pretty far
35:33
off actual prices if you use this type
35:35
of formulas still people call this the
35:37
fundamental value of equity and then the
35:40
rest is sort of more speculative but the
35:43
point is that the speculative component
35:44
moves at all is is responsible for a
35:47
very large share of the volatility in
35:49
asset in equity price in any event I'm
35:51
not going to ask you about this kind of
35:54
yeah for that final equation on the SL
35:56
uh there's no
35:58
like expression for Q it's here keep
36:02
going forever it doesn't stop yeah it
36:06
just discounted more and more and more
36:08
so you would expect it to be less and
36:09
less important but if the thing is
36:11
blowing up then you know it maybe it may
36:15
dominate the the the the heavier and
36:18
heavier discounting because it's further
36:19
further out in the future and that's the
36:22
way you create theories of bubbles you
36:23
can even come up with rational bubbles
36:25
into the way but again that's what of
36:29
course uh what else ah then we look at
36:32
what is the effect of an expansionary
36:34
monetary policy on asset prices and we
36:36
said well obviously it's going to if
36:38
lower interest rate that's going to
36:39
increase the value of any asset that
36:41
pays in the future returns and so it
36:44
typically is typically the case that
36:45
that expansion in Monet monetary policy
36:48
will lead to an appreciation of all
36:50
assets uh most assets but certainly
36:53
bonds will go up directly because that's
36:56
where the interest rate has the maximum
36:58
the clearest effect but it's also the
37:00
case that it tends to be bullish for
37:01
Equity as well no it's that got interest
37:04
rate and that a lot of the response of
37:07
equity to news has to do with expected
37:11
behavior of the FED in the future do you
37:13
think that this will lead them to
37:14
increase interest rate or to lower
37:16
interest rate and things of that kind
37:18
and again I think that's a little too
37:20
complicated for you for
37:22
now it said what is the effect of an
37:24
increase in consumer spending on asset
37:26
prices well that depends I mean it's
37:29
clear that that if consumers become more
37:32
bullish that's going to tend to lead to
37:33
more cash flows for the firms so Equity
37:36
at least will go up bonds no because
37:38
they don't the coupon is set fixed
37:40
doesn't depend on whether the econom is
37:42
doing better or worse I'm assuming
37:44
there's no default risk ER but it
37:47
depends a lot of what you expect the FED
37:48
to do if the FED if you think that this
37:51
is going to trigger a Fed hike then it's
37:53
bad news for bonds you know because the
37:55
F the bonds do not benefit from the
37:58
economic activity and and they get hurt
38:00
by higher interest rate so it depends a
38:03
lot on what you anticipate the FED to do
38:04
or not but again I think this is a bit
38:07
more complicated than what you need to
38:08
know okay the last step was
38:13
to H bring expectations into the aslm
38:16
model I said the model we discussed
38:17
through the course on the aslm except
38:20
for the part where we put the exchange
38:22
rate where we you know we we have to
38:25
think about the future exchange rates
38:26
and things like that it was really
38:28
overweight the present in reality
38:31
expectations matter a lot for consu
38:33
consumers decisions for firm's decisions
38:35
and so on probably matters even more
38:37
than the future than the present okay
38:40
ER and so so what we did is we expanded
38:46
H the islm to include expectation we see
38:49
well consumers not only worry about
38:51
disposable income this part will show up
38:54
in your test so so you should understand
38:57
what what the eslm model is and do the
38:59
comparative Statics that correspond to
39:02
this model so what we did here is as
39:04
well consumers not only worry about the
39:06
current disposable income H they also
39:09
worry about the income they receive in
39:11
the future through financial asset
39:13
Financial wealth or through their future
39:15
labor income that's what we call human
39:17
wealth but the point is that
39:19
expectations about the future matter for
39:21
consumption in the first part of the
39:24
course we we summarize all that in that
39:27
little parameters c0 which said
39:28
consumers can be bullish or not but a
39:31
lot of what happens here is what shifts
39:32
c0 in the first part of the of the
39:35
course and and this also highlight an
39:37
important concept which is typically if
39:40
you expect something to have only a
39:42
temporary transitory consequence it will
39:45
move consumption little relative to when
39:47
you expect that change to be permanent
39:49
so you expect current income to be up
39:52
but but future income to go back to a
39:53
lower level that's not going to change
39:55
current consumption a lot however if you
39:57
think there's a change that will
39:58
increase in consumers income permanently
40:01
up well that will increase not only this
40:03
but also wealth human wealth and that
40:05
will lead to a much larger response of
40:07
consumption
40:08
okay we did more or less for the same
40:11
for investment obviously what matters
40:13
for investment is the is future cash
40:15
flows and and there we talk about the
40:17
concept of depreciation but really was
40:20
this was expected present discounted
40:21
value of the cash flow generated by by
40:24
an extra unit of capital so expected per
40:28
Val discounted value
40:30
formula so we said you know we we in the
40:34
first part of the course we just look at
40:36
an investment function that has output
40:38
here and then we have an interest rate
40:39
here where now we have something that's
40:40
more complicated has future output which
40:43
has appr proxim for future cash flows
40:45
but also current and future interest
40:47
rates because those affect the value of
40:50
those future cash flows H in terms of
40:52
today's
40:53
dollars and we put all of this together
40:56
and we ended up with an expanded
40:59
aggregate demand in which ER you know in
41:03
which we had the same parameters that we
41:05
had ER when we did the static
41:09
model without expectations but now we
41:12
get sort of the same things repeated
41:15
here one year ahead because it it
41:18
matters not only for aggregate demand
41:20
not only the income the consumers are
41:22
receiving today or the sales that firms
41:24
are making today but also what they
41:26
expect to have next year here it matters
41:29
what the taxes they're paying today but
41:31
also what they expect to pay in the
41:32
future the interest rate matters not
41:35
only today but also what they expect the
41:37
interest rate to be in the future and so
41:38
on okay so the bottom line is that we if
41:42
we now look at the slm model I said now
41:45
we have lots of more parameters all
41:47
these things that happen in the future
41:48
are new
41:50
parameters H I said notice notice that
41:54
also this curve now is a lot steeper
41:57
why is that well because if you change
41:59
the interest rate today without without
42:01
changing the interest rate in the future
42:03
then that has a small effect okay and so
42:07
I said now this is becomes very steep
42:10
but the equivalent to what we did the
42:12
static model is a is a situation where
42:14
you cut the interest rate today say the
42:16
Central Bank cuts the interest rate
42:18
today but it also convinces the public
42:20
that they will also keep the interest
42:22
rate low in the next period that is not
42:25
only you move along the SAS but you also
42:27
persuade the public that the interest
42:30
rate will be lower in the future that
42:32
will shift yes to the right and then
42:34
therefore therefore you're going to get
42:35
a much larger kick out of monetary
42:37
policy and pol monetary policy is a lot
42:40
about forward guidance is that you know
42:42
you cut interest rate today but you're
42:44
also telling there's always a speech
42:46
after they they take the policy action
42:48
which they talk about how they see
42:50
interest rates going in the future and
42:52
all of that that's because you want to
42:54
have maximum power okay if you if if you
42:57
just tell the market I'm going to change
42:59
the interest rate for now and then
43:00
nothing else that's going to have a very
43:02
limited impact to have a large impact
43:04
out of monetary policy you have to
43:06
convince them that you will also affect
43:08
the interest R path in the
43:11
future same sort of situation here the
43:13
other parameters is what happens if for
43:16
example you expect future output to go
43:18
up H well that's going to shift a yes to
43:21
the right that's yet another reason why
43:23
convincing people that you're going to
43:25
cut interest rate in the future as well
43:27
they going to keep them low in the
43:29
future shift yes even more because if
43:31
you're going to keep the interest rate
43:33
low in the future that means probably
43:34
the future output will be higher and
43:36
since future output is higher that
43:38
increases human wealth and that means
43:40
consumption will tend to go up okay but
43:43
do play with this and and again the the
43:46
it's important to have this distinction
43:49
between the impact of temporary things
43:51
which is much smaller and and the the
43:54
impact of permanent things which is
43:56
bigger because it affect
43:57
wealth
44:01
okay oh that's an example okay so
44:04
monetary policy again ER that's just if
44:08
if you don't persuade the public that
44:10
you're going to change the interest rate
44:11
in the future then it just a movement
44:12
along but if you also convince them that
44:16
you will remain sort of H lose monetary
44:19
conditions in next year then that that
44:22
effectively shift the yes to the right
44:24
for for a variety of Reon for two
44:25
reasons at least that's much more
44:29
expansionary the last thing we did is
44:32
fiscal policy I said well fiscal policy
44:34
fiscal policy today is contraction and
44:36
there's no doubt of that but it can have
44:39
but there are episodes and I show you
44:40
the Irish episode in which actually may
44:43
end up going the other way around in
44:45
which you cut expenditure today which is
44:47
contractionary but you end up actually
44:49
having an expansion but for that the
44:51
only way that can happen is that if
44:54
somehow you affect expectations in a
44:55
very significant way so that's what I
44:58
said if if you ever get sort of a a a
45:01
strange correl response to to a policy
45:04
announcement is probably because there
45:06
has been a big effect on expectations so
45:09
I show you the case of Ireland because
45:10
there a case that was famous in which
45:12
all the people talk about there was a
45:14
fiscal deficit as the big drug in the
45:16
economy that there was going to be a big
45:18
Day of Reckoning and that you and so on
45:21
so forth so once they dealt with it sort
45:23
of expectations they realize they could
45:25
cut interest rates then they could
45:27
realiz that that that also that that
45:30
this Malay and the economy was going to
45:31
go away so people became optimistic
45:33
about the future and so on and they end
45:35
up with an expansion okay that shows you
45:38
how important expectations are so
45:41
economic policy in general you the the
45:44
direct immediate effect is what we have
45:46
been discussing throughout the course
45:48
but a lot of its power and even the sort
45:51
of perverse or or or or good synergies
45:53
that you get out of them has to do with
45:55
what you do to with expect patience okay
45:58
good
— end of transcript —
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