1 00:00:16,600 --> 00:00:23,199 let me um continue with the eslm PC 2 00:00:20,320 --> 00:00:26,118 model in fact I want to I Rush a little 3 00:00:23,199 --> 00:00:30,118 because I was over excited with the svb 4 00:00:26,118 --> 00:00:31,000 bank event H and and I want to make sure 5 00:00:30,118 --> 00:00:34,280 that you 6 00:00:31,000 --> 00:00:36,200 certainly understand this this mle it's 7 00:00:34,280 --> 00:00:38,280 going to be very 8 00:00:36,200 --> 00:00:40,840 important and I think it's one of the 9 00:00:38,280 --> 00:00:41,879 most important moles in in this course 10 00:00:40,840 --> 00:00:45,200 as I said 11 00:00:41,878 --> 00:00:47,238 before also I want to use a little bit 12 00:00:45,200 --> 00:00:49,280 more the this Mo itself to explain what 13 00:00:47,238 --> 00:00:51,558 is going on right now today we got hit 14 00:00:49,280 --> 00:00:55,359 by a second shock from the financial 15 00:00:51,558 --> 00:00:59,320 system and uh so so it's getting it's 16 00:00:55,359 --> 00:01:02,800 getting exciting these days so let me 17 00:00:59,320 --> 00:01:05,478 skip all this and remind you that that's 18 00:01:02,799 --> 00:01:08,039 what we we that's that's the ISL MPC 19 00:01:05,478 --> 00:01:11,118 model which I said is nothing else and 20 00:01:08,040 --> 00:01:13,840 just integrating the islm analysis with 21 00:01:11,118 --> 00:01:16,159 the Philips curve this is the part and I 22 00:01:13,840 --> 00:01:18,439 said and at this point I will follow the 23 00:01:16,159 --> 00:01:20,920 book and and assume that the central 24 00:01:18,438 --> 00:01:22,319 bank can control the real interest rate 25 00:01:20,920 --> 00:01:23,799 rather than the nominal interest rate 26 00:01:22,319 --> 00:01:26,118 which is what really controls in 27 00:01:23,799 --> 00:01:27,720 practice H but I'm going to make that 28 00:01:26,118 --> 00:01:29,640 assumption so the pictures have less 29 00:01:27,719 --> 00:01:33,280 curves moving around when when things 30 00:01:29,640 --> 00:01:37,439 are mov moving H as when we do Dynamics 31 00:01:33,280 --> 00:01:42,040 okay but that's just a eslm nothing 32 00:01:37,438 --> 00:01:46,239 different um then we look at the Philips 33 00:01:42,040 --> 00:01:48,880 curve and I said well we can we can uh I 34 00:01:46,239 --> 00:01:52,438 this is not very useful because you know 35 00:01:48,879 --> 00:01:54,399 in the as part I have output here and in 36 00:01:52,438 --> 00:01:55,718 the Philips curves I have inflation but 37 00:01:54,399 --> 00:01:57,359 then I have an employment and I don't 38 00:01:55,718 --> 00:02:00,640 want to be carrying around sort of three 39 00:01:57,359 --> 00:02:03,519 variables endogenous variables 40 00:02:00,640 --> 00:02:05,439 ER and and and so it's you know it's 41 00:02:03,519 --> 00:02:07,879 difficult to diagrams in in three 42 00:02:05,438 --> 00:02:11,120 dimension is everything less clear so 43 00:02:07,879 --> 00:02:14,199 I'm going to replace H this unemployment 44 00:02:11,120 --> 00:02:15,680 here for for output and it's very easy 45 00:02:14,199 --> 00:02:18,639 to do that with the production function 46 00:02:15,680 --> 00:02:21,439 we have because output is just equal to 47 00:02:18,639 --> 00:02:23,359 employment and employment is just equal 48 00:02:21,439 --> 00:02:25,719 to the labor force time one minus the 49 00:02:23,360 --> 00:02:28,400 rate of unemployment and we could Define 50 00:02:25,719 --> 00:02:30,359 a concept of potential output as simply 51 00:02:28,400 --> 00:02:32,840 that output that happens when employment 52 00:02:30,360 --> 00:02:34,519 is equal to the Natural level of 53 00:02:32,840 --> 00:02:37,360 employment which is equal to the labor 54 00:02:34,519 --> 00:02:39,599 force Time 1 minus the natural rate of 55 00:02:37,360 --> 00:02:41,280 unemployment and taking the difference 56 00:02:39,598 --> 00:02:43,560 subtracting the second line from the 57 00:02:41,280 --> 00:02:45,360 first one you get a concept that is used 58 00:02:43,560 --> 00:02:47,318 very frequently in microeconomics which 59 00:02:45,360 --> 00:02:49,319 is called is a concept of the output gap 60 00:02:47,318 --> 00:02:51,759 an output Gap refers to the difference 61 00:02:49,318 --> 00:02:53,399 between actual output and potential 62 00:02:51,759 --> 00:02:55,439 output in which potential output is 63 00:02:53,400 --> 00:02:57,599 nothing else of the level of output that 64 00:02:55,439 --> 00:02:59,479 you get when employment when an 65 00:02:57,598 --> 00:03:00,479 employment is at the natural rate of an 66 00:02:59,479 --> 00:03:02,639 employment 67 00:03:00,479 --> 00:03:05,199 so we get this output Gap is related to 68 00:03:02,639 --> 00:03:08,639 the employment gap and now we can 69 00:03:05,199 --> 00:03:11,560 replace the employment gap from here 70 00:03:08,639 --> 00:03:13,798 with the output Gap and we end up with a 71 00:03:11,560 --> 00:03:16,759 Philip Cur in the space of inflation and 72 00:03:13,799 --> 00:03:19,080 output gap which is something we can 73 00:03:16,759 --> 00:03:23,919 integrate very easily withm model that 74 00:03:19,080 --> 00:03:25,680 has output in it okay so that's H so the 75 00:03:23,919 --> 00:03:29,399 snpc model is 76 00:03:25,680 --> 00:03:31,560 really combining this equation with that 77 00:03:29,400 --> 00:03:35,959 equation and some model about expected 78 00:03:31,560 --> 00:03:38,039 inflation that's what the MPC model is 79 00:03:35,959 --> 00:03:40,080 so I gave you one example here one model 80 00:03:38,039 --> 00:03:42,479 of inflation this is a case of that 81 00:03:40,080 --> 00:03:45,439 central banks do not like the an Anor 82 00:03:42,479 --> 00:03:47,199 unanchor inflation expectation that's my 83 00:03:45,438 --> 00:03:50,120 model of expectation then my Philips 84 00:03:47,199 --> 00:03:52,119 curve I plug this into my Philips curve 85 00:03:50,120 --> 00:03:55,840 and I get this relationship between the 86 00:03:52,120 --> 00:03:57,680 change in inflation and the output Gap 87 00:03:55,840 --> 00:03:59,878 and it's an increasing relationship and 88 00:03:57,680 --> 00:04:00,920 that's what I'm plotting here for any 89 00:03:59,878 --> 00:04:03,840 given 90 00:04:00,919 --> 00:04:07,000 level for any given level of YN then as 91 00:04:03,840 --> 00:04:09,000 a increase output the Philips curve the 92 00:04:07,000 --> 00:04:10,479 change in inflation the left hand side 93 00:04:09,000 --> 00:04:12,919 the difference between inflation expect 94 00:04:10,479 --> 00:04:14,919 to inflation Rises that's the reason 95 00:04:12,919 --> 00:04:16,639 this upward is sloping and the reason 96 00:04:14,919 --> 00:04:18,879 this Rises has to do with all the things 97 00:04:16,639 --> 00:04:21,280 that happen in the labor market no if an 98 00:04:18,879 --> 00:04:23,000 employment if output Rises meaning an 99 00:04:21,279 --> 00:04:24,918 employment is falling you need more 100 00:04:23,000 --> 00:04:26,759 employment to produce more output if 101 00:04:24,918 --> 00:04:29,399 that's the case it's more wage pressure 102 00:04:26,759 --> 00:04:30,840 that leads to a price pressure because 103 00:04:29,399 --> 00:04:33,399 there is a the market in between wages 104 00:04:30,839 --> 00:04:37,359 and prices and that's the way you get 105 00:04:33,399 --> 00:04:40,399 into inflation okay so I gave you one 106 00:04:37,360 --> 00:04:42,960 example says okay 107 00:04:40,399 --> 00:04:45,000 suppose that we have some equilibrium 108 00:04:42,959 --> 00:04:48,478 level of output this which is the result 109 00:04:45,000 --> 00:04:52,199 of this monetary policy this rate set by 110 00:04:48,478 --> 00:04:54,079 by by the central bank and and that's 111 00:04:52,199 --> 00:04:55,840 the is which is a function of you know 112 00:04:54,079 --> 00:04:57,399 the fiscal policy of the country how 113 00:04:55,839 --> 00:05:01,079 confident are consumers and all these 114 00:04:57,399 --> 00:05:03,399 kind of things so in quiz one we really 115 00:05:01,079 --> 00:05:05,560 worry only about this top diagram okay 116 00:05:03,399 --> 00:05:08,038 and all the shocks we had were shocks 117 00:05:05,560 --> 00:05:10,120 that happen in this top diagram and we 118 00:05:08,038 --> 00:05:12,000 and we look at what happened to Output 119 00:05:10,120 --> 00:05:15,720 to equilibrium output as a 120 00:05:12,000 --> 00:05:17,319 result now this hasn't changed it hasn't 121 00:05:15,720 --> 00:05:19,560 change that block is the same as it used 122 00:05:17,319 --> 00:05:22,918 to be the only difference that we have 123 00:05:19,560 --> 00:05:24,519 here is that this level of output H 124 00:05:22,918 --> 00:05:26,959 which is the equilibrium level of output 125 00:05:24,519 --> 00:05:28,680 at any point in time needs not be equal 126 00:05:26,959 --> 00:05:30,680 to potential output and if it is not 127 00:05:28,680 --> 00:05:32,560 equal to potential output that will lead 128 00:05:30,680 --> 00:05:34,160 to something with inflation either 129 00:05:32,560 --> 00:05:37,478 inflation disinflation or something of 130 00:05:34,160 --> 00:05:39,199 that kind in this particular case the 131 00:05:37,478 --> 00:05:40,839 equilibrium level of output which is 132 00:05:39,199 --> 00:05:43,120 still determined as we used to determine 133 00:05:40,839 --> 00:05:44,279 it happens to be higher than the natural 134 00:05:43,120 --> 00:05:47,639 rate of 135 00:05:44,279 --> 00:05:50,599 output and if if output is higher than 136 00:05:47,639 --> 00:05:52,680 the rate of output that means this is 137 00:05:50,600 --> 00:05:55,160 positive which means inflation is rising 138 00:05:52,680 --> 00:05:56,639 and that's exactly what we see here it 139 00:05:55,160 --> 00:05:58,680 means inflation is above expected 140 00:05:56,639 --> 00:06:00,478 inflation when expected inflation is 141 00:05:58,680 --> 00:06:03,759 equal to lag inflation 142 00:06:00,478 --> 00:06:05,680 then that means inflation is rising okay 143 00:06:03,759 --> 00:06:08,840 and that's what we have 144 00:06:05,680 --> 00:06:11,720 here so any question about that so this 145 00:06:08,839 --> 00:06:14,079 is we just what we did is kept analysis 146 00:06:11,720 --> 00:06:16,240 we used to have and now we added this 147 00:06:14,079 --> 00:06:19,959 diagram here at the bottom because it 148 00:06:16,240 --> 00:06:21,319 turns out that yes any equilibrium here 149 00:06:19,959 --> 00:06:22,758 if I move the inter around I'm going to 150 00:06:21,319 --> 00:06:24,319 change the equilibrium level of output 151 00:06:22,759 --> 00:06:27,080 those all those are equilibrium levels 152 00:06:24,319 --> 00:06:29,879 output but that doesn't mean that that 153 00:06:27,079 --> 00:06:32,159 they're consistent with the natural ER H 154 00:06:29,879 --> 00:06:34,000 with potential output and if it's not 155 00:06:32,160 --> 00:06:35,800 equal to potential output it's a valid 156 00:06:34,000 --> 00:06:38,120 equilibrium at any point in time but 157 00:06:35,800 --> 00:06:40,720 it's going to lead to issues on the 158 00:06:38,120 --> 00:06:43,120 inflation front that's all that the the 159 00:06:40,720 --> 00:06:46,800 second diagram here tells you that we 160 00:06:43,120 --> 00:06:49,319 get issues on the inflation front with 161 00:06:46,800 --> 00:06:51,000 any equilibrium level of output that is 162 00:06:49,319 --> 00:06:54,720 different from the natural rate of 163 00:06:51,000 --> 00:06:57,038 output that's what this diagram 164 00:06:54,720 --> 00:06:58,360 does so then I said well and that's what 165 00:06:57,038 --> 00:07:00,360 happen in the short run that's what it 166 00:06:58,360 --> 00:07:04,120 does so we keep doing what we used to do 167 00:07:00,360 --> 00:07:05,960 in the first seven lectures or so and uh 168 00:07:04,120 --> 00:07:07,959 this diagram just tells us what are the 169 00:07:05,959 --> 00:07:10,918 implications for inflation that's in the 170 00:07:07,959 --> 00:07:13,758 short run the medium run we said is when 171 00:07:10,918 --> 00:07:16,439 we is that process in which output 172 00:07:13,759 --> 00:07:19,240 converges back to the Natural rate to 173 00:07:16,439 --> 00:07:22,038 potential output how does that happen 174 00:07:19,240 --> 00:07:23,400 well it involves the central bank but 175 00:07:22,038 --> 00:07:25,120 it's not that the central bank is doing 176 00:07:23,399 --> 00:07:27,159 crazyy things effect Central Bank is 177 00:07:25,120 --> 00:07:29,639 reacting to what the economy is telling 178 00:07:27,160 --> 00:07:31,199 it needs to do here is a central bank 179 00:07:29,639 --> 00:07:33,840 that supposed had 180 00:07:31,199 --> 00:07:36,038 was before doing whatever change in the 181 00:07:33,839 --> 00:07:38,198 interest rate or in the deliver this 182 00:07:36,038 --> 00:07:40,318 equilibrium output here had an inflation 183 00:07:38,199 --> 00:07:42,639 of around 2% that was consistent with 184 00:07:40,319 --> 00:07:44,039 the target it had now suddenly it finds 185 00:07:42,639 --> 00:07:47,038 itself in a situation like this and 186 00:07:44,038 --> 00:07:51,279 inflation starts climbing okay you get 187 00:07:47,038 --> 00:07:53,120 3% one year 4% the next one 6 nine in a 188 00:07:51,279 --> 00:07:54,758 situation like that well it's very 189 00:07:53,120 --> 00:07:56,639 natural for that Central Bank if it's a 190 00:07:54,759 --> 00:07:58,919 responsible Central Bank to react to 191 00:07:56,639 --> 00:08:00,120 that and the only reaction a central 192 00:07:58,918 --> 00:08:01,680 bank can have 193 00:08:00,120 --> 00:08:03,840 the main the main reaction can have is 194 00:08:01,680 --> 00:08:05,759 to raise interest rates okay and that's 195 00:08:03,839 --> 00:08:07,878 exactly what it starts happening if the 196 00:08:05,759 --> 00:08:10,280 Central Bank finds itself with inflation 197 00:08:07,879 --> 00:08:13,240 in this Cas is that is accelerating it 198 00:08:10,279 --> 00:08:14,799 will start increasing interest rate and 199 00:08:13,240 --> 00:08:17,240 this process of acceleration of 200 00:08:14,800 --> 00:08:19,598 inflation in this case would only stop 201 00:08:17,240 --> 00:08:22,240 when output is equal to the Natural to 202 00:08:19,598 --> 00:08:25,038 potential output okay and output is 203 00:08:22,240 --> 00:08:26,759 equal we can Define implicitly what that 204 00:08:25,038 --> 00:08:28,279 interest rate is and we can call it the 205 00:08:26,759 --> 00:08:30,000 natural rate of interest rate sometimes 206 00:08:28,279 --> 00:08:32,799 we call it we sell 207 00:08:30,000 --> 00:08:35,958 interest rate of interest rate neutral 208 00:08:32,799 --> 00:08:37,799 interest rate R star lots of names for 209 00:08:35,958 --> 00:08:39,000 this interest rate but this interest is 210 00:08:37,799 --> 00:08:41,718 simply the one that gives us an 211 00:08:39,000 --> 00:08:46,320 equilibrium output in our asln diagram 212 00:08:41,719 --> 00:08:48,240 that is equal to potential output that's 213 00:08:46,320 --> 00:08:51,360 that's all that this RN means and here 214 00:08:48,240 --> 00:08:53,159 I'm solving it you know it's is the rate 215 00:08:51,360 --> 00:08:55,639 that implicitly gives us an equilibrium 216 00:08:53,159 --> 00:08:58,159 output here H that is equal to the 217 00:08:55,639 --> 00:08:59,879 Natural rate of output okay that defines 218 00:08:58,159 --> 00:09:04,240 it implicitly 219 00:08:59,879 --> 00:09:07,639 okay there we are is all that 220 00:09:04,240 --> 00:09:09,519 clear yes okay I think you're going to 221 00:09:07,639 --> 00:09:12,000 have a a big chunk of your current pie 222 00:09:09,519 --> 00:09:13,440 set is about this model and so on and 223 00:09:12,000 --> 00:09:15,600 and that's a good thing and you'll see 224 00:09:13,440 --> 00:09:17,920 it also in the next one this again I 225 00:09:15,600 --> 00:09:20,320 think this is important then I talk 226 00:09:17,919 --> 00:09:23,919 about the difference between anchor and 227 00:09:20,320 --> 00:09:25,440 an anchor expectations I said look here 228 00:09:23,919 --> 00:09:28,000 we have a situation that suppose we 229 00:09:25,440 --> 00:09:30,600 started at 2% and then we found ourself 230 00:09:28,000 --> 00:09:33,078 in a situation like that that means 231 00:09:30,600 --> 00:09:35,959 inflation start building up we got to 9% 232 00:09:33,078 --> 00:09:37,719 or so so now the FED gets scared and it 233 00:09:35,958 --> 00:09:39,679 starts raising interest rates so that's 234 00:09:37,720 --> 00:09:41,879 what we're moving up lower in output and 235 00:09:39,679 --> 00:09:45,359 as it lowers output reduces the output 236 00:09:41,879 --> 00:09:47,278 Gap and therefore reduces the change in 237 00:09:45,360 --> 00:09:49,639 inflation here but inflation keeps 238 00:09:47,278 --> 00:09:52,000 rising in this particular model because 239 00:09:49,639 --> 00:09:53,559 expected inflation is an anchor and I 240 00:09:52,000 --> 00:09:56,278 said well suppose that eventually the 241 00:09:53,559 --> 00:09:58,479 FED gets to that interest rate here so 242 00:09:56,278 --> 00:10:00,519 we get to situation like that and I 243 00:09:58,480 --> 00:10:03,360 asked the question has the FED solved 244 00:10:00,519 --> 00:10:05,919 the problem now okay finally we got to 245 00:10:03,360 --> 00:10:07,360 situation where the the interest rate is 246 00:10:05,919 --> 00:10:09,360 equal to an natural rate of interest 247 00:10:07,360 --> 00:10:11,320 rate that tells me that output is equal 248 00:10:09,360 --> 00:10:14,000 to potential output that tells me here 249 00:10:11,320 --> 00:10:17,000 that inflation is not changing problem 250 00:10:14,000 --> 00:10:20,480 is that we already had inflation of 9% 251 00:10:17,000 --> 00:10:22,200 at some point so so here inflation stops 252 00:10:20,480 --> 00:10:24,480 rising in this particular model with 253 00:10:22,200 --> 00:10:27,440 expected inflation an anchor expected 254 00:10:24,480 --> 00:10:29,560 inflation but stopping is not enough 255 00:10:27,440 --> 00:10:30,600 because that's gives leaves us level of 256 00:10:29,559 --> 00:10:33,479 inflation of 257 00:10:30,600 --> 00:10:36,200 9% that means that the FED in order to 258 00:10:33,480 --> 00:10:39,240 bring back inflation to 2% it needs to 259 00:10:36,200 --> 00:10:44,480 go into this region so inflation starts 260 00:10:39,240 --> 00:10:46,839 coming down from 9% 7% 6% 5% and so on 261 00:10:44,480 --> 00:10:49,560 okay so if you have an anchor 262 00:10:46,839 --> 00:10:50,720 expectation and and inflation overshoots 263 00:10:49,559 --> 00:10:52,239 you're going to have to cause a 264 00:10:50,720 --> 00:10:55,000 recession and probably a severe 265 00:10:52,240 --> 00:10:56,799 recession there's no way around that and 266 00:10:55,000 --> 00:10:59,000 that's what the FED has been struggling 267 00:10:56,799 --> 00:11:01,078 to do is is struggling not to because 268 00:10:59,000 --> 00:11:03,559 the Fed we are in a situation not only 269 00:11:01,078 --> 00:11:05,559 in the US but in the US in particular 270 00:11:03,559 --> 00:11:08,879 where inflation is way above the target 271 00:11:05,559 --> 00:11:11,679 level H but expected inflation has been 272 00:11:08,879 --> 00:11:14,879 more or less stable and so this when 273 00:11:11,679 --> 00:11:17,919 people talk about being able to restore 274 00:11:14,879 --> 00:11:20,399 sort of reasonable levels of inflation 275 00:11:17,919 --> 00:11:22,838 in a soft landed manner with a soft 276 00:11:20,399 --> 00:11:25,839 Landing that means that you don't need 277 00:11:22,839 --> 00:11:28,120 to cost a b recession to bring inflation 278 00:11:25,839 --> 00:11:30,079 back to 2% you just can bring it 279 00:11:28,120 --> 00:11:32,480 smoothly here with this model of 280 00:11:30,078 --> 00:11:34,759 expected inflation doesn't work but if 281 00:11:32,480 --> 00:11:37,360 expect if the Bank Central Bank has 282 00:11:34,759 --> 00:11:39,078 credibility H and inflation remain Anor 283 00:11:37,360 --> 00:11:41,399 people continue to believe that the FED 284 00:11:39,078 --> 00:11:43,439 will go back to 2% then you don't need 285 00:11:41,399 --> 00:11:45,839 to cause a big recession otherwise you 286 00:11:43,440 --> 00:11:47,320 need to invest in bringing expectations 287 00:11:45,839 --> 00:11:48,839 down and that the only way you can 288 00:11:47,320 --> 00:11:51,320 invest in doing that is causing a 289 00:11:48,839 --> 00:11:54,480 recession okay but that's the reason I 290 00:11:51,320 --> 00:11:56,399 said central banks worry so much about 291 00:11:54,480 --> 00:11:57,800 keeping inflation credibility because 292 00:11:56,399 --> 00:12:03,120 otherwise they need to 293 00:11:57,799 --> 00:12:05,278 overshoot in order to restore um long 294 00:12:03,120 --> 00:12:07,839 run balance 295 00:12:05,278 --> 00:12:09,838 okay 296 00:12:07,839 --> 00:12:12,480 good 297 00:12:09,839 --> 00:12:15,760 now you may Wonder well this I mean this 298 00:12:12,480 --> 00:12:18,480 looks pretty simple to do no just if you 299 00:12:15,759 --> 00:12:21,559 have a problem like this just go quickly 300 00:12:18,480 --> 00:12:23,800 to that point there no and then the 301 00:12:21,559 --> 00:12:26,359 problem is over you don't let inflation 302 00:12:23,799 --> 00:12:28,879 build to 9% or something like that you 303 00:12:26,360 --> 00:12:31,919 react immediately the problem is there's 304 00:12:28,879 --> 00:12:34,399 a f sentence that was going by Milton 305 00:12:31,919 --> 00:12:37,399 fredman is that monetary policy acts on 306 00:12:34,399 --> 00:12:39,919 the economy with long and variable lags 307 00:12:37,399 --> 00:12:41,480 so first of all it's very difficult at 308 00:12:39,919 --> 00:12:43,599 any point in time to know where is 309 00:12:41,480 --> 00:12:45,320 potential output or what is the natural 310 00:12:43,600 --> 00:12:47,519 rate of unemployment I mean you sort of 311 00:12:45,320 --> 00:12:50,040 sense it but the truth is that the only 312 00:12:47,519 --> 00:12:52,159 way you really know is is by looking at 313 00:12:50,039 --> 00:12:53,879 inflation so it's inflation that really 314 00:12:52,159 --> 00:12:56,360 tells you that you're one side of the 315 00:12:53,879 --> 00:12:58,399 other it's very difficult to you you 316 00:12:56,360 --> 00:13:00,240 have some historical average and so on 317 00:12:58,399 --> 00:13:01,639 but these things do move move around so 318 00:13:00,240 --> 00:13:04,959 it's difficult at any point in time to 319 00:13:01,639 --> 00:13:07,720 know whether you you are at our end or 320 00:13:04,958 --> 00:13:10,479 not the second thing is that here 321 00:13:07,720 --> 00:13:11,920 everything happens immediately if I move 322 00:13:10,480 --> 00:13:13,639 immediately then output immediately 323 00:13:11,919 --> 00:13:15,479 jumps here that's not the way monetary 324 00:13:13,639 --> 00:13:18,759 policy operates in practice it takes 325 00:13:15,480 --> 00:13:22,278 time for monetary policy to to to affect 326 00:13:18,759 --> 00:13:25,278 the economy and so this the situation 327 00:13:22,278 --> 00:13:28,559 that happened I I would say until last 328 00:13:25,278 --> 00:13:31,559 week was the FED knew that the inflation 329 00:13:28,559 --> 00:13:33,399 was still to too high but it but it also 330 00:13:31,559 --> 00:13:35,638 knew that it had done a lot he had hiked 331 00:13:33,399 --> 00:13:38,759 rates very aggressively by a lot and 332 00:13:35,639 --> 00:13:40,959 since there are lags between the the 333 00:13:38,759 --> 00:13:44,078 increasing interest rate and and the 334 00:13:40,958 --> 00:13:45,958 declining output the fed's concern was 335 00:13:44,078 --> 00:13:47,719 well it's clear that I still have 336 00:13:45,958 --> 00:13:49,198 inflation but it may well be the case 337 00:13:47,720 --> 00:13:51,920 that when this thing finally hits the 338 00:13:49,198 --> 00:13:53,758 economy it hits us too much and we end 339 00:13:51,919 --> 00:13:58,278 up in a recession and an unwanted 340 00:13:53,759 --> 00:13:59,839 recession that was a concern okay H now 341 00:13:58,278 --> 00:14:01,360 with what is happening right now there's 342 00:13:59,839 --> 00:14:03,360 a little bit of a concern that we got to 343 00:14:01,360 --> 00:14:05,560 that point because things were very slow 344 00:14:03,360 --> 00:14:08,839 for a variety of reasons but now 345 00:14:05,559 --> 00:14:11,078 something broke and the question is now 346 00:14:08,839 --> 00:14:13,199 that something has broken well will we 347 00:14:11,078 --> 00:14:15,399 sort of decelerate the economy very very 348 00:14:13,198 --> 00:14:18,439 fast and that's a concern that's what is 349 00:14:15,399 --> 00:14:20,600 happening right now okay but that's what 350 00:14:18,440 --> 00:14:21,959 makes monetary policy much more 351 00:14:20,600 --> 00:14:23,800 difficult than this little diagram is 352 00:14:21,958 --> 00:14:25,518 that you you have all this lags these 353 00:14:23,799 --> 00:14:30,758 uncertainties and all these 354 00:14:25,519 --> 00:14:30,759 nonlinearities and Sly things happen 355 00:14:30,879 --> 00:14:35,799 okay let me tell you when things can go 356 00:14:33,799 --> 00:14:38,919 really really wrong it's not the issue 357 00:14:35,799 --> 00:14:41,399 now but but we're very close to that 358 00:14:38,919 --> 00:14:43,479 during the global recession Japan has 359 00:14:41,399 --> 00:14:45,519 experienced several episodes like this 360 00:14:43,480 --> 00:14:50,440 which is the following suppose you have 361 00:14:45,519 --> 00:14:52,198 a situation where ER your inflation is 362 00:14:50,440 --> 00:14:54,800 low typically these things happen in 363 00:14:52,198 --> 00:14:57,278 situations where your inflation is low 364 00:14:54,799 --> 00:14:59,879 and for whatever reason your natural 365 00:14:57,278 --> 00:15:02,480 rate of unemployment is is 366 00:14:59,879 --> 00:15:06,000 negative so you have inflation close to 367 00:15:02,480 --> 00:15:08,360 zero say and then the natural rate 368 00:15:06,000 --> 00:15:11,078 of interest rate is 369 00:15:08,360 --> 00:15:12,440 negative what's the problem suppose you 370 00:15:11,078 --> 00:15:14,439 have a zero lower 371 00:15:12,440 --> 00:15:16,240 bound well if you have a zero lower 372 00:15:14,440 --> 00:15:17,560 bound means that you're not going to hit 373 00:15:16,240 --> 00:15:20,198 this 374 00:15:17,559 --> 00:15:21,559 rate the best you can do if inflation is 375 00:15:20,198 --> 00:15:23,359 around zero then you set the nominal 376 00:15:21,559 --> 00:15:24,958 interest rate to zero and then the real 377 00:15:23,360 --> 00:15:29,680 interest rate is around 378 00:15:24,958 --> 00:15:33,479 zero well the problem is that at zero 379 00:15:29,679 --> 00:15:36,078 you generate negative 380 00:15:33,480 --> 00:15:38,120 inflation but if you generate negative 381 00:15:36,078 --> 00:15:40,638 inflation and the nominal interest rate 382 00:15:38,120 --> 00:15:42,919 is fixed at zero then now you get a 383 00:15:40,639 --> 00:15:44,360 positive real interest rate because the 384 00:15:42,919 --> 00:15:46,318 real interest rate is equal to the 385 00:15:44,360 --> 00:15:49,519 nominal interest rate which is zero 386 00:15:46,318 --> 00:15:52,360 minus inflation expected inflation but 387 00:15:49,519 --> 00:15:54,799 if expected inflation or inflation is 388 00:15:52,360 --> 00:15:56,440 negative minus minus is positive so that 389 00:15:54,799 --> 00:15:59,159 means your real interest rate is 390 00:15:56,440 --> 00:16:00,800 actually positive so your really you you 391 00:15:59,159 --> 00:16:02,000 wanted something negative but you end up 392 00:16:00,799 --> 00:16:04,278 with something 393 00:16:02,000 --> 00:16:05,480 positive that means now you have a big 394 00:16:04,278 --> 00:16:07,600 gap 395 00:16:05,480 --> 00:16:10,000 here so 396 00:16:07,600 --> 00:16:11,879 inflation you get into a deflation now 397 00:16:10,000 --> 00:16:14,440 now inflation is very very low it gets 398 00:16:11,879 --> 00:16:16,399 very negative well your real as 399 00:16:14,440 --> 00:16:18,440 inflation gets more and more negative 400 00:16:16,399 --> 00:16:20,600 your real interest keeps climbing so you 401 00:16:18,440 --> 00:16:23,920 keep moving further and further away 402 00:16:20,600 --> 00:16:26,000 from the natural rate of interest rate 403 00:16:23,919 --> 00:16:29,360 that's something that is very scary for 404 00:16:26,000 --> 00:16:31,120 an economy is a def deflationary trap 405 00:16:29,360 --> 00:16:34,440 and that's the way you get 406 00:16:31,120 --> 00:16:36,198 into deep recessions in fact that's what 407 00:16:34,440 --> 00:16:36,839 happened during the Great Recession in 408 00:16:36,198 --> 00:16:38,559 the 409 00:16:36,839 --> 00:16:42,000 US the 410 00:16:38,559 --> 00:16:44,318 no during the Great Depression in the US 411 00:16:42,000 --> 00:16:46,078 okay during the Great Recession we were 412 00:16:44,318 --> 00:16:48,919 close to it but we didn't get quite 413 00:16:46,078 --> 00:16:52,838 there in in because lots of things were 414 00:16:48,919 --> 00:16:54,879 done to prevent a repeat of the Great 415 00:16:52,839 --> 00:16:57,759 Depression the one of the biggest 416 00:16:54,879 --> 00:17:01,078 problems with the Great Depression ER 417 00:16:57,759 --> 00:17:03,399 was that ER monetary policy was not 418 00:17:01,078 --> 00:17:04,798 against the zero lower bound but it was 419 00:17:03,399 --> 00:17:07,640 very slow to 420 00:17:04,798 --> 00:17:10,599 react okay they were in a situation like 421 00:17:07,640 --> 00:17:10,600 in this diagram 422 00:17:10,759 --> 00:17:16,078 here and and but they kept the interest 423 00:17:12,959 --> 00:17:18,558 rate high and they moveed very slowly 424 00:17:16,078 --> 00:17:20,959 and when they tried to catch up well 425 00:17:18,558 --> 00:17:22,639 they were into deflation environment so 426 00:17:20,959 --> 00:17:24,078 the real interet was moving away from 427 00:17:22,640 --> 00:17:26,480 them despite the fact that they were 428 00:17:24,078 --> 00:17:28,678 moving the nominal interest rate down 429 00:17:26,480 --> 00:17:31,599 and that you can see here so there the 430 00:17:28,679 --> 00:17:33,080 Great depression starts around 1929 it 431 00:17:31,599 --> 00:17:36,599 starts really in 432 00:17:33,079 --> 00:17:39,319 1929 H an employment initially was low 433 00:17:36,599 --> 00:17:41,798 then nominal interest rate was around 5% 434 00:17:39,319 --> 00:17:44,480 and inflation rate growth declined very 435 00:17:41,798 --> 00:17:47,000 rapidly in inflation rate was around 436 00:17:44,480 --> 00:17:50,640 zero so you had a one year the real 437 00:17:47,000 --> 00:17:53,759 interest rate was around 5% as well okay 438 00:17:50,640 --> 00:17:57,200 well things got worse and employment 439 00:17:53,759 --> 00:17:58,919 began to climb very rapidly and so the 440 00:17:57,200 --> 00:18:00,640 FED began to lower interest rates 441 00:17:58,919 --> 00:18:04,480 nominal interest rate you know it went 442 00:18:00,640 --> 00:18:06,520 from 5% to 4% those were unusually low 443 00:18:04,480 --> 00:18:08,759 interest rate for the time but the 444 00:18:06,519 --> 00:18:11,720 problem is that the inflation by then 445 00:18:08,759 --> 00:18:13,158 was minus 2 and a half% so the real 446 00:18:11,720 --> 00:18:14,480 interest rate they were lowering the 447 00:18:13,159 --> 00:18:16,799 nominal interest rate but the real 448 00:18:14,480 --> 00:18:19,519 interest rate was rising and 449 00:18:16,798 --> 00:18:23,079 unemployment accordingly was Rising as 450 00:18:19,519 --> 00:18:24,798 well it kept going no look see then they 451 00:18:23,079 --> 00:18:28,798 began to cut the interest rate more 452 00:18:24,798 --> 00:18:31,279 aggressively okay but but we got into 453 00:18:28,798 --> 00:18:33,158 real deflation minus 10% or so so the 454 00:18:31,279 --> 00:18:36,839 real interest rate kept 455 00:18:33,159 --> 00:18:39,760 climbing at that point was a very poor 456 00:18:36,839 --> 00:18:42,639 Le time interest rate hike was a 457 00:18:39,759 --> 00:18:44,279 disaster for unemployment and because it 458 00:18:42,640 --> 00:18:46,400 really hied the interest rate real 459 00:18:44,279 --> 00:18:48,000 interest rate even more and eventually 460 00:18:46,400 --> 00:18:49,880 got got out of it with a bunch of 461 00:18:48,000 --> 00:18:51,359 policies that were non monetary policies 462 00:18:49,880 --> 00:18:53,919 but but 463 00:18:51,359 --> 00:18:55,519 um but that's that's what happened so so 464 00:18:53,919 --> 00:18:57,400 the Great Depression was very much a 465 00:18:55,519 --> 00:19:01,079 story of this 466 00:18:57,400 --> 00:19:03,038 kind in which essentially we get we fall 467 00:19:01,079 --> 00:19:05,918 fell into depression so that interest 468 00:19:03,038 --> 00:19:07,679 rate when began to climb and got the 469 00:19:05,919 --> 00:19:09,240 economy deeper and deeper into recession 470 00:19:07,679 --> 00:19:11,038 and employment Higher and Higher and so 471 00:19:09,240 --> 00:19:13,000 on and at some point monetary policy 472 00:19:11,038 --> 00:19:15,319 just didn't work so that's the reason 473 00:19:13,000 --> 00:19:18,279 you have essentially do massive fiscal 474 00:19:15,319 --> 00:19:18,279 policy to get out of 475 00:19:19,558 --> 00:19:24,639 it let's let me talk about some of the 476 00:19:22,159 --> 00:19:27,679 shocks we have discussed in the context 477 00:19:24,640 --> 00:19:31,240 of this more complete model now ER and 478 00:19:27,679 --> 00:19:33,200 and actually okay let me go let me talk 479 00:19:31,240 --> 00:19:36,159 about sort of two canonical type shocks 480 00:19:33,200 --> 00:19:38,120 you can have two broad type of shocks or 481 00:19:36,159 --> 00:19:40,200 or policies in in this 482 00:19:38,119 --> 00:19:42,199 Ms that you want to 483 00:19:40,200 --> 00:19:44,279 analyze some of them are aggregate 484 00:19:42,200 --> 00:19:46,480 demand either policies or shocks 485 00:19:44,279 --> 00:19:48,599 whatever those are things that you know 486 00:19:46,480 --> 00:19:52,079 aggregate demand policies move the is 487 00:19:48,599 --> 00:19:54,319 curve okay the is and the LM but moves 488 00:19:52,079 --> 00:19:57,759 operates in the in the in the in the 489 00:19:54,319 --> 00:20:00,519 Goods Market so this is one case of a 490 00:19:57,759 --> 00:20:02,480 contractionary f policy no a fiscal 491 00:20:00,519 --> 00:20:04,240 consolidation so what happens here 492 00:20:02,480 --> 00:20:07,159 suppose you start an equilibrium level 493 00:20:04,240 --> 00:20:08,759 of output H equal to Natural rate of 494 00:20:07,159 --> 00:20:10,679 output but now for whatever reason we're 495 00:20:08,759 --> 00:20:13,079 running deficits that are very large you 496 00:20:10,679 --> 00:20:15,240 want to reduce the size of the deficit 497 00:20:13,079 --> 00:20:17,000 well you move the is to the left no you 498 00:20:15,240 --> 00:20:19,519 cut government expenditure you increase 499 00:20:17,000 --> 00:20:21,720 taxes that will bring output below the 500 00:20:19,519 --> 00:20:23,720 natural rate of output you go to the 501 00:20:21,720 --> 00:20:26,120 Philips curve here that means inflation 502 00:20:23,720 --> 00:20:29,000 now you you get into deflationary forces 503 00:20:26,119 --> 00:20:30,959 or inflation starts declining the result 504 00:20:29,000 --> 00:20:32,798 of that so in the short run you get 505 00:20:30,960 --> 00:20:35,120 exactly what we had in lecture five six 506 00:20:32,798 --> 00:20:37,279 or whatever know you get a contraction 507 00:20:35,119 --> 00:20:40,000 in real output but on top of that you 508 00:20:37,279 --> 00:20:42,480 start getting inflation coming down or 509 00:20:40,000 --> 00:20:45,519 even going negative and as a result of 510 00:20:42,480 --> 00:20:47,400 that the central bank will react and it 511 00:20:45,519 --> 00:20:49,599 will react and that reaction will stop 512 00:20:47,400 --> 00:20:52,000 when in the long run well when output 513 00:20:49,599 --> 00:20:54,918 goes back to the initial level of output 514 00:20:52,000 --> 00:20:57,319 it's natural rate of output okay so the 515 00:20:54,919 --> 00:20:59,280 point of this picture that is new 516 00:20:57,319 --> 00:21:01,240 relative to things you already knew 517 00:20:59,279 --> 00:21:02,798 is that in the short run you get very 518 00:21:01,240 --> 00:21:05,480 much the type of responses we had 519 00:21:02,798 --> 00:21:07,440 earlier on in the medium run that is 520 00:21:05,480 --> 00:21:09,079 when now in the medium run you don't get 521 00:21:07,440 --> 00:21:12,038 that a fiscal consolation does not 522 00:21:09,079 --> 00:21:14,240 reduce output in the medium Run Okay a 523 00:21:12,038 --> 00:21:16,079 fiscal consolation what does is reduces 524 00:21:14,240 --> 00:21:18,120 the real interest rate in the in the in 525 00:21:16,079 --> 00:21:21,359 the long in the medium run okay so you 526 00:21:18,119 --> 00:21:23,439 see here output eventually goes back to 527 00:21:21,359 --> 00:21:25,879 that level with a much lower real 528 00:21:23,440 --> 00:21:29,480 interest rate and and 529 00:21:25,880 --> 00:21:31,840 U the the point is sometimes this this 530 00:21:29,480 --> 00:21:33,880 path this path that takes you output 531 00:21:31,839 --> 00:21:36,119 down initially and then comes back can 532 00:21:33,880 --> 00:21:38,679 be very painful it can take a long time 533 00:21:36,119 --> 00:21:41,239 generate a recession and so on and 534 00:21:38,679 --> 00:21:43,559 sometimes it can happen in easier 535 00:21:41,240 --> 00:21:45,679 conditions and be faster and so on many 536 00:21:43,558 --> 00:21:47,879 of the policies agreements that people 537 00:21:45,679 --> 00:21:50,278 have people that understand what they're 538 00:21:47,880 --> 00:21:51,960 talking about had to do with the speed 539 00:21:50,278 --> 00:21:53,640 at which these things happen so 540 00:21:51,960 --> 00:21:55,120 sometimes you know people can agree that 541 00:21:53,640 --> 00:21:56,759 you need a fiscal consolidation but 542 00:21:55,119 --> 00:21:59,038 someone think no this stuff is going to 543 00:21:56,759 --> 00:22:00,679 be very slow and so I don't want to 544 00:21:59,038 --> 00:22:01,960 incur in a very deep recession for very 545 00:22:00,679 --> 00:22:04,000 long just to adjust a little bit the 546 00:22:01,960 --> 00:22:06,278 fiscal deficit and others may think the 547 00:22:04,000 --> 00:22:09,558 opposite okay it's it's mostly about the 548 00:22:06,278 --> 00:22:11,798 speed but shorter response to a fiscal 549 00:22:09,558 --> 00:22:14,558 consolidation or to any aggregate demand 550 00:22:11,798 --> 00:22:17,400 contraction is different than the medium 551 00:22:14,558 --> 00:22:17,399 ter 552 00:22:18,200 --> 00:22:22,558 response and again the signals for the 553 00:22:21,000 --> 00:22:23,839 central bank that it needs to move 554 00:22:22,558 --> 00:22:25,918 interest rate they all come from this 555 00:22:23,839 --> 00:22:28,639 block here inflation falling that tells 556 00:22:25,919 --> 00:22:32,038 the Central Bank oops we may have a 557 00:22:28,640 --> 00:22:35,759 problem and so on another kind of shock 558 00:22:32,038 --> 00:22:37,558 that is is is is is more complicated and 559 00:22:35,759 --> 00:22:39,960 that has played a role actually very 560 00:22:37,558 --> 00:22:43,119 much in the recovery from covid is some 561 00:22:39,960 --> 00:22:45,640 sort of supply side shock for example an 562 00:22:43,119 --> 00:22:49,199 oil shock okay price of energy goes up 563 00:22:45,640 --> 00:22:51,400 or something like that well that one how 564 00:22:49,200 --> 00:22:53,240 do you analyze that the a supply size 565 00:22:51,400 --> 00:22:56,360 shock is not something that comes from 566 00:22:53,240 --> 00:22:58,640 the that we go to the slm part of the 567 00:22:56,359 --> 00:23:00,240 mall a supply size shock remember we 568 00:22:58,640 --> 00:23:01,880 analyze it when we did analyze the 569 00:23:00,240 --> 00:23:03,640 natural rate of natural rate of 570 00:23:01,880 --> 00:23:06,120 unemployment it's something that affects 571 00:23:03,640 --> 00:23:09,480 the supply side of the economy we can 572 00:23:06,119 --> 00:23:11,119 model that as an increase in the markup 573 00:23:09,480 --> 00:23:14,200 and we know that an increase in the 574 00:23:11,119 --> 00:23:18,038 markup will increase the natural rate of 575 00:23:14,200 --> 00:23:22,759 unemployment that means that that that 576 00:23:18,038 --> 00:23:22,759 this shock will do what to potential 577 00:23:24,400 --> 00:23:30,840 output so an energy shock especially if 578 00:23:27,839 --> 00:23:34,879 it's a persist one will operate like a 579 00:23:30,839 --> 00:23:36,759 markup shock and that we know will 580 00:23:34,880 --> 00:23:39,200 increase the natural rate of 581 00:23:36,759 --> 00:23:41,200 unemployment so what happens to the to 582 00:23:39,200 --> 00:23:44,038 potential 583 00:23:41,200 --> 00:23:46,519 output goes down of course it's it's 584 00:23:44,038 --> 00:23:48,240 know output is equal to employment to 585 00:23:46,519 --> 00:23:49,639 labor force times 1 minus the natural 586 00:23:48,240 --> 00:23:51,319 rate of unemployment if the natural rate 587 00:23:49,640 --> 00:23:54,159 of unemployment goes up then the 588 00:23:51,319 --> 00:23:56,079 potential output goes down so that is 589 00:23:54,159 --> 00:23:58,640 not a shift in the top diagram it's a 590 00:23:56,079 --> 00:24:01,359 shift in the lower diagram it says we 591 00:23:58,640 --> 00:24:03,840 used to have this Philips curve and now 592 00:24:01,359 --> 00:24:06,319 the Philips curve has shifted to the 593 00:24:03,839 --> 00:24:08,359 left because we have a new natural rate 594 00:24:06,319 --> 00:24:12,960 of an output and remember the natural 595 00:24:08,359 --> 00:24:14,759 rate of output is that point when a ER 596 00:24:12,960 --> 00:24:16,759 output equal to the Natural rate of 597 00:24:14,759 --> 00:24:20,599 output doesn't produce inflationary 598 00:24:16,759 --> 00:24:22,919 forces okay so what happened with this 599 00:24:20,599 --> 00:24:25,678 shock here so suppose the economy was in 600 00:24:22,919 --> 00:24:29,240 this equilibrium here and now it gets 601 00:24:25,679 --> 00:24:31,240 hit by an oil shock 602 00:24:29,240 --> 00:24:33,960 in the short run if no one reacts 603 00:24:31,240 --> 00:24:37,359 nothing happens to Output doesn't move 604 00:24:33,960 --> 00:24:37,360 much but what 605 00:24:41,440 --> 00:24:45,399 happens you see if I don't move 606 00:24:43,919 --> 00:24:47,399 something in this part of the diagram 607 00:24:45,398 --> 00:24:49,000 and not move equilibrium output in the 608 00:24:47,398 --> 00:24:50,558 short run equilibrium output is 609 00:24:49,000 --> 00:24:52,919 determined exactly in the same way we 610 00:24:50,558 --> 00:24:56,918 have determined up to now so if we get a 611 00:24:52,919 --> 00:24:59,600 markup shock nothing happens to Output 612 00:24:56,919 --> 00:25:04,720 if no no one no if no moves nothing 613 00:24:59,599 --> 00:25:04,719 happens to help in the short but what 614 00:25:05,398 --> 00:25:11,038 happens that we may not like yeah 615 00:25:08,839 --> 00:25:13,959 exactly what happen is the the Philips 616 00:25:11,038 --> 00:25:16,919 curve went up before that level of 617 00:25:13,960 --> 00:25:20,240 output was consistent with no changes in 618 00:25:16,919 --> 00:25:22,720 inflation now it's not we get an 619 00:25:20,240 --> 00:25:26,038 increase in inflation so the first place 620 00:25:22,720 --> 00:25:28,079 where you'll see a the effect of the of 621 00:25:26,038 --> 00:25:29,720 of of the oil shock here is inflation 622 00:25:28,079 --> 00:25:31,359 will pick up remember the price of 623 00:25:29,720 --> 00:25:33,360 gasoline going up and all those things 624 00:25:31,359 --> 00:25:36,278 well that's where you see it first 625 00:25:33,359 --> 00:25:37,678 before activity Falls you see it there 626 00:25:36,278 --> 00:25:40,119 that's what mess up the Philips curve 627 00:25:37,679 --> 00:25:42,480 also in the 70s and 80s we going to see 628 00:25:40,119 --> 00:25:44,519 lots of shocks of this kind initially 629 00:25:42,480 --> 00:25:46,240 unemployment didn't move M much but 630 00:25:44,519 --> 00:25:48,558 inflation keeps 631 00:25:46,240 --> 00:25:50,120 climbing so that's what happens well 632 00:25:48,558 --> 00:25:51,879 obviously when that happens if it's 633 00:25:50,119 --> 00:25:53,119 persistent typically central banks if 634 00:25:51,880 --> 00:25:54,640 they think it's very short live they're 635 00:25:53,119 --> 00:25:56,798 not going to react to this stuff but if 636 00:25:54,640 --> 00:25:59,600 if it is persistent and they think it's 637 00:25:56,798 --> 00:26:02,359 persistent then the reaction is what 638 00:25:59,599 --> 00:26:03,519 well they need to this only means that 639 00:26:02,359 --> 00:26:06,359 the natural rate of 640 00:26:03,519 --> 00:26:08,960 an the the natural rate of interest has 641 00:26:06,359 --> 00:26:12,119 gone up no because I need to for that 642 00:26:08,960 --> 00:26:14,278 same is I need to bring down equilibrium 643 00:26:12,119 --> 00:26:16,639 output that means I need a higher 644 00:26:14,278 --> 00:26:19,119 natural rate of interest rate or a 645 00:26:16,640 --> 00:26:20,720 higher rst star so what the FED needs to 646 00:26:19,119 --> 00:26:22,558 do the Central Bank needs to do is just 647 00:26:20,720 --> 00:26:23,640 start increasing interest rate that's an 648 00:26:22,558 --> 00:26:25,798 natural 649 00:26:23,640 --> 00:26:28,360 response a lot of what happened during 650 00:26:25,798 --> 00:26:30,240 the covid why inflation pick up so much 651 00:26:28,359 --> 00:26:33,398 much in in Co is because we had a shock 652 00:26:30,240 --> 00:26:35,558 of this kind it was not energy the 653 00:26:33,398 --> 00:26:38,479 energy shock came later but it was 654 00:26:35,558 --> 00:26:40,599 supply side transport transport cost and 655 00:26:38,480 --> 00:26:41,960 stuff like that the network the 656 00:26:40,599 --> 00:26:44,759 production Network and things like that 657 00:26:41,960 --> 00:26:47,120 that broke down but they thought it was 658 00:26:44,759 --> 00:26:48,558 going to be very temporary so 659 00:26:47,119 --> 00:26:51,879 understanding this model they thought 660 00:26:48,558 --> 00:26:54,240 okay look this this Curve will come back 661 00:26:51,880 --> 00:26:55,799 come back that but by itself so better 662 00:26:54,240 --> 00:26:58,480 not react right now why cause a 663 00:26:55,798 --> 00:27:02,038 recession if really this Curve will come 664 00:26:58,480 --> 00:27:03,839 down back down by itself well the 665 00:27:02,038 --> 00:27:06,919 problem is that it didn't come back by 666 00:27:03,839 --> 00:27:09,319 itself that fast some things came up 667 00:27:06,919 --> 00:27:11,679 fairly fast some others did not in 668 00:27:09,319 --> 00:27:15,240 particular labor for participation did 669 00:27:11,679 --> 00:27:17,840 not come sufficiently fast back and so 670 00:27:15,240 --> 00:27:20,240 that's the reason we stay too long in a 671 00:27:17,839 --> 00:27:23,199 situation like this and that's one of 672 00:27:20,240 --> 00:27:25,759 the main reasons inflation sort of creep 673 00:27:23,200 --> 00:27:29,278 up in in the US and also in other places 674 00:27:25,759 --> 00:27:31,519 in the world in Europe the big reason 675 00:27:29,278 --> 00:27:36,240 for for why inflation picked up there is 676 00:27:31,519 --> 00:27:36,240 because this curve move a lot up why is 677 00:27:40,440 --> 00:27:45,558 that exactly you know they had a massive 678 00:27:43,480 --> 00:27:48,558 energy shock and so that moved that 679 00:27:45,558 --> 00:27:50,960 curve up a 680 00:27:48,558 --> 00:27:54,079 lot 681 00:27:50,960 --> 00:27:55,960 good let's I want to now return to what 682 00:27:54,079 --> 00:27:59,000 is going on right 683 00:27:55,960 --> 00:28:01,919 now ER oh actually first I'm going to 684 00:27:59,000 --> 00:28:04,359 yeah right now meaning the last few days 685 00:28:01,919 --> 00:28:06,360 so it turns out that this diagram that 686 00:28:04,359 --> 00:28:09,079 that I use for the fiscal consolidation 687 00:28:06,359 --> 00:28:12,000 shock can also be used to understand a 688 00:28:09,079 --> 00:28:16,960 little bit what happens with 689 00:28:12,000 --> 00:28:19,038 the um Silicon Valley Bank event okay 690 00:28:16,960 --> 00:28:21,200 remember we model that as a credit shock 691 00:28:19,038 --> 00:28:24,558 we say like like that X we had it's like 692 00:28:21,200 --> 00:28:26,840 X going up well X going up that's 693 00:28:24,558 --> 00:28:30,200 exactly that it moves the yes to the 694 00:28:26,839 --> 00:28:34,119 left so a shock to 695 00:28:30,200 --> 00:28:37,200 X to to the a panic of the kind that we 696 00:28:34,119 --> 00:28:38,439 saw is like that it moves the to the 697 00:28:37,200 --> 00:28:41,600 left why is 698 00:28:38,440 --> 00:28:44,360 that so for any given level of the safe 699 00:28:41,599 --> 00:28:47,558 real interest rate a panic a shock to 700 00:28:44,359 --> 00:28:49,918 credit and so on moves the a to the left 701 00:28:47,558 --> 00:28:49,918 why is 702 00:28:52,960 --> 00:28:58,440 that exactly so so the real the safe 703 00:28:55,640 --> 00:29:01,640 interest rate doesn't go up but but but 704 00:28:58,440 --> 00:29:04,240 what goes up is is is the cost of 705 00:29:01,640 --> 00:29:07,600 borrowing because you know firms need to 706 00:29:04,240 --> 00:29:09,399 pay this this extra risk premium and and 707 00:29:07,599 --> 00:29:12,639 then for any given safe interest rate 708 00:29:09,398 --> 00:29:14,398 real interest rate firms have to pay 709 00:29:12,640 --> 00:29:15,960 more which means there is less 710 00:29:14,398 --> 00:29:17,839 investment for any given level of the 711 00:29:15,960 --> 00:29:20,960 real interest rate and so the is moves 712 00:29:17,839 --> 00:29:23,038 to the left and if that happens then you 713 00:29:20,960 --> 00:29:27,558 start getting deflationary 714 00:29:23,038 --> 00:29:30,480 forces okay so again all this happens 715 00:29:27,558 --> 00:29:32,798 very quickly here in reality I told you 716 00:29:30,480 --> 00:29:35,399 there are lots of lags and so on but 717 00:29:32,798 --> 00:29:37,679 markets begin to anticipate what will 718 00:29:35,398 --> 00:29:40,798 happen and 719 00:29:37,679 --> 00:29:43,080 so so markets begin to anticipate so so 720 00:29:40,798 --> 00:29:44,918 in the in the immediate output doesn't 721 00:29:43,079 --> 00:29:47,000 collapse immediately anything and 722 00:29:44,919 --> 00:29:49,519 inflation doesn't be doesn't collapse 723 00:29:47,000 --> 00:29:52,440 immediately but markets realize that 724 00:29:49,519 --> 00:29:54,599 there are Long Bar there lcks but but 725 00:29:52,440 --> 00:29:56,440 there is a shock already so so it's 726 00:29:54,599 --> 00:29:59,480 likely that these things will 727 00:29:56,440 --> 00:30:01,558 happen and and and and it's likely that 728 00:29:59,480 --> 00:30:04,079 this will happen and it's also likely 729 00:30:01,558 --> 00:30:06,359 that the FED will react to 730 00:30:04,079 --> 00:30:09,839 that what should be the reaction of the 731 00:30:06,359 --> 00:30:09,839 FED if this stuff gets to be 732 00:30:12,000 --> 00:30:17,880 persistent how do you get out of a shock 733 00:30:14,278 --> 00:30:17,880 like that if you really want to go back 734 00:30:18,038 --> 00:30:23,720 there you cut interest rates okay in the 735 00:30:21,720 --> 00:30:25,200 case of the US they were hiking 736 00:30:23,720 --> 00:30:27,319 interestate because we're deing with 737 00:30:25,200 --> 00:30:29,720 dealing with high inflation this tells 738 00:30:27,319 --> 00:30:32,200 you well you should slow down the pace 739 00:30:29,720 --> 00:30:34,640 of hiking again they don't do it 740 00:30:32,200 --> 00:30:36,360 immediately they meet next week but the 741 00:30:34,640 --> 00:30:38,240 markets don't need to wait for the FED 742 00:30:36,359 --> 00:30:40,678 they anticipate what the FED is likely 743 00:30:38,240 --> 00:30:44,440 to do okay and they start betting on 744 00:30:40,679 --> 00:30:47,480 that so let me show you next a bunch of 745 00:30:44,440 --> 00:30:49,919 charts that show you that someone in the 746 00:30:47,480 --> 00:30:51,319 market understand these mechanics okay a 747 00:30:49,919 --> 00:30:55,519 lot of people because the prices are 748 00:30:51,319 --> 00:30:55,519 moving exactly that 749 00:30:56,038 --> 00:31:02,558 way so 750 00:30:58,558 --> 00:31:04,278 this is the ER oh this is something this 751 00:31:02,558 --> 00:31:06,558 is the one year ahead inflation 752 00:31:04,278 --> 00:31:08,440 expectation as traded in the market it's 753 00:31:06,558 --> 00:31:11,278 called inflation break even the one-ear 754 00:31:08,440 --> 00:31:12,919 inflation break even so if you these 755 00:31:11,278 --> 00:31:15,398 things are traded in the market and you 756 00:31:12,919 --> 00:31:18,600 can trade expected inflation at all the 757 00:31:15,398 --> 00:31:21,158 maturities you want so this is what the 758 00:31:18,599 --> 00:31:22,918 market was expecting before this shock 759 00:31:21,159 --> 00:31:24,840 you know infl we getting hotter and 760 00:31:22,919 --> 00:31:27,519 hotter numbers so the economy was 761 00:31:24,839 --> 00:31:31,158 inflation expected inflation as price in 762 00:31:27,519 --> 00:31:34,519 the market Market was climbing okay one 763 00:31:31,159 --> 00:31:35,760 year out and then the shock came and 764 00:31:34,519 --> 00:31:39,000 look what happened to expect the 765 00:31:35,759 --> 00:31:39,000 inflation boom it 766 00:31:39,240 --> 00:31:48,319 collapse okay why is that well people 767 00:31:44,079 --> 00:31:50,918 thought this shock that leads to that 768 00:31:48,319 --> 00:31:53,678 okay that's what they thought this 769 00:31:50,919 --> 00:31:55,799 bounce was markets got a little excited 770 00:31:53,679 --> 00:31:58,519 yesterday it was a little risk on 771 00:31:55,798 --> 00:32:01,480 environment today they lost all that 772 00:31:58,519 --> 00:32:03,399 but but for a shock I'm going to tell 773 00:32:01,480 --> 00:32:05,919 you about in a few minutes 774 00:32:03,398 --> 00:32:08,599 but anyways but the point I wanted to 775 00:32:05,919 --> 00:32:11,038 highlight is again expected inflation 776 00:32:08,599 --> 00:32:13,719 was getting a little out of control and 777 00:32:11,038 --> 00:32:15,519 then this x shock came the the Panic 778 00:32:13,720 --> 00:32:17,600 shock and then immediately expected 779 00:32:15,519 --> 00:32:20,880 inflation decline because people 780 00:32:17,599 --> 00:32:23,119 anticipated something like this okay the 781 00:32:20,880 --> 00:32:24,200 market anticipated something like that 782 00:32:23,119 --> 00:32:28,429 what is 783 00:32:24,200 --> 00:32:29,840 that this is the the 784 00:32:28,430 --> 00:32:34,200 [Music] 785 00:32:29,839 --> 00:32:37,079 um the markets expected next hike so 786 00:32:34,200 --> 00:32:39,679 March 22nd the the FED will decide on 787 00:32:37,079 --> 00:32:41,199 the increase in interest rate remember 788 00:32:39,679 --> 00:32:43,559 the FED had decided as I said in the 789 00:32:41,200 --> 00:32:46,038 previous lecture to go for a path of 50 790 00:32:43,558 --> 00:32:47,359 basis points initially very high but 791 00:32:46,038 --> 00:32:49,480 since a couple of meetings ago they 792 00:32:47,359 --> 00:32:51,398 decided to slow down to 25 basis points 793 00:32:49,480 --> 00:32:53,960 precisely because they want to wait and 794 00:32:51,398 --> 00:32:55,398 see a bit what what a mess do we have I 795 00:32:53,960 --> 00:32:58,278 mean there's long variable lacks they 796 00:32:55,398 --> 00:33:00,119 have increased rates a lot and and so on 797 00:32:58,278 --> 00:33:02,839 but so they had gone back to a pace of 798 00:33:00,119 --> 00:33:05,638 25 so if you see in you know somewhere 799 00:33:02,839 --> 00:33:07,638 here in in February 22nd if you ask the 800 00:33:05,638 --> 00:33:08,678 market what what do you think will be 801 00:33:07,638 --> 00:33:11,199 the next 802 00:33:08,679 --> 00:33:14,639 hike there will be lots of answers 803 00:33:11,200 --> 00:33:17,480 trades and so on but the the when I say 804 00:33:14,638 --> 00:33:20,319 answers I mean what is price what is 805 00:33:17,480 --> 00:33:23,278 traded this financial instrument the the 806 00:33:20,319 --> 00:33:25,558 average answer was 30 basis points 30 807 00:33:23,278 --> 00:33:27,079 basis point is that most of the people 808 00:33:25,558 --> 00:33:29,000 thought that they were going to increase 809 00:33:27,079 --> 00:33:30,439 the the interest rate by 25 basis points 810 00:33:29,000 --> 00:33:32,200 and there were a few guys out there that 811 00:33:30,440 --> 00:33:34,600 thought the FED doesn't increase the 812 00:33:32,200 --> 00:33:39,960 interest rate by 33 basis points that's 813 00:33:34,599 --> 00:33:41,240 25 50 75 okay so this 30 is meant that 814 00:33:39,960 --> 00:33:42,880 almost everyone thought it was going to 815 00:33:41,240 --> 00:33:44,720 be 25 but there were a few people that 816 00:33:42,880 --> 00:33:47,278 were concerned that could be higher than 817 00:33:44,720 --> 00:33:50,038 that what happened here we start getting 818 00:33:47,278 --> 00:33:51,599 very hot numbers on inflation and so all 819 00:33:50,038 --> 00:33:54,319 of a sudden the equilibrium changed 820 00:33:51,599 --> 00:33:56,278 dramatically and we went to 45 which 821 00:33:54,319 --> 00:34:00,000 means most people then thought in the 822 00:33:56,278 --> 00:34:02,200 market that the next hike in in in on on 823 00:34:00,000 --> 00:34:05,919 March 22nd was going to be 50 basis 824 00:34:02,200 --> 00:34:09,800 points and a few people St stay at 25 825 00:34:05,919 --> 00:34:12,079 that's the reason H this is not 0. five 826 00:34:09,800 --> 00:34:13,839 but it was almost price in that point 827 00:34:12,079 --> 00:34:15,919 when people say price in they're talking 828 00:34:13,838 --> 00:34:19,239 about this what is the hike that price 829 00:34:15,918 --> 00:34:21,319 in is this statistic look that's what 830 00:34:19,239 --> 00:34:25,319 happened with 831 00:34:21,320 --> 00:34:28,919 the Silicon Valley Bank event okay a 832 00:34:25,320 --> 00:34:31,679 collapse in this thing now now is is 833 00:34:28,918 --> 00:34:34,960 trading at around 13 basis points that 834 00:34:31,679 --> 00:34:37,639 means most of the people think that the 835 00:34:34,960 --> 00:34:41,639 Traders here think that there will be no 836 00:34:37,639 --> 00:34:43,000 hike at all okay so a few days ago they 837 00:34:41,639 --> 00:34:45,878 all thought there was going to be 50 838 00:34:43,000 --> 00:34:47,358 basis point which is a big hike H and 839 00:34:45,878 --> 00:34:49,519 now most people think there will be no 840 00:34:47,358 --> 00:34:52,078 hike whatsoever but a few think that 841 00:34:49,519 --> 00:34:54,719 it's going to be 25 me actually it's 842 00:34:52,079 --> 00:34:55,960 almost 50/50 no I think today is a 843 00:34:54,719 --> 00:34:59,679 little lower than that but it's almost 844 00:34:55,960 --> 00:35:02,320 50/50 that is 25 or zero that's that's 845 00:34:59,679 --> 00:35:04,679 what what it is but had you ask anyone 846 00:35:02,320 --> 00:35:06,559 around here and certainly around here is 847 00:35:04,679 --> 00:35:09,078 there any chance of zero and there would 848 00:35:06,559 --> 00:35:12,639 be no one literally is that contract was 849 00:35:09,079 --> 00:35:15,280 not traded okay well you see things 850 00:35:12,639 --> 00:35:17,000 happen accidents happen so now that's 851 00:35:15,280 --> 00:35:20,000 where where we are 852 00:35:17,000 --> 00:35:20,000 at 853 00:35:20,719 --> 00:35:26,719 now if this all last a week and and 854 00:35:23,800 --> 00:35:29,400 everything gets resolved it doesn't have 855 00:35:26,719 --> 00:35:31,118 a lot of macro iic consequences okay 856 00:35:29,400 --> 00:35:32,760 it's just a little Panic you know some 857 00:35:31,119 --> 00:35:36,720 people make money some people lose money 858 00:35:32,760 --> 00:35:39,800 and so on but but but but this can be a 859 00:35:36,719 --> 00:35:42,439 very problematic shock actually because 860 00:35:39,800 --> 00:35:44,200 what you see here is that this is a size 861 00:35:42,440 --> 00:35:46,760 this is Silicon Valley 862 00:35:44,199 --> 00:35:48,358 Bank these are all the rest the banks 863 00:35:46,760 --> 00:35:51,880 smaller than 864 00:35:48,358 --> 00:35:53,799 that H it turns out that all these bank 865 00:35:51,880 --> 00:35:55,119 at this moment are reshuffling their 866 00:35:53,800 --> 00:35:56,880 portfolios they're becoming very 867 00:35:55,119 --> 00:35:58,680 conservative because they don't want to 868 00:35:56,880 --> 00:36:00,640 be exposed to similar risk they realized 869 00:35:58,679 --> 00:36:03,039 the environment became very unfriendly 870 00:36:00,639 --> 00:36:05,039 to you know that can be runs on banks in 871 00:36:03,039 --> 00:36:06,519 any moment despite the fact that it's a 872 00:36:05,039 --> 00:36:08,440 big policy package out there but people 873 00:36:06,519 --> 00:36:10,358 are still withdrawing lots of deposits 874 00:36:08,440 --> 00:36:12,400 from a small Banks small and Regional 875 00:36:10,358 --> 00:36:14,759 Banks and they all deposi it in JP 876 00:36:12,400 --> 00:36:18,039 Morgan you know the big Banks so there's 877 00:36:14,760 --> 00:36:21,240 lots of deposits that despite the the 878 00:36:18,039 --> 00:36:23,000 the the insurance the the the the the 879 00:36:21,239 --> 00:36:24,838 blanket insurance that is implicit at 880 00:36:23,000 --> 00:36:26,920 least at the moment lots of deposits 881 00:36:24,838 --> 00:36:29,358 from these sectors are moving to these 882 00:36:26,920 --> 00:36:31,240 major Banks here okay that's called it's 883 00:36:29,358 --> 00:36:34,480 called a flight to 884 00:36:31,239 --> 00:36:37,598 Quality now the problem of that for the 885 00:36:34,480 --> 00:36:40,639 economy as a whole is that small Banks 886 00:36:37,599 --> 00:36:41,318 and Regional Banks play a huge role in 887 00:36:40,639 --> 00:36:45,400 in 888 00:36:41,318 --> 00:36:48,559 lending okay I 889 00:36:45,400 --> 00:36:50,039 think a little more than 50% for example 890 00:36:48,559 --> 00:36:53,799 of the commercial and Industrial loans 891 00:36:50,039 --> 00:36:55,920 are made by small Banks ER 80% of the 892 00:36:53,800 --> 00:36:58,119 mortgages are given by a small Banks so 893 00:36:55,920 --> 00:36:59,599 it so it has a big 894 00:36:58,119 --> 00:37:01,880 potential consequence what I'm trying to 895 00:36:59,599 --> 00:37:05,680 say is that X may stay high for quite a 896 00:37:01,880 --> 00:37:08,200 bit of time okay and that's a 897 00:37:05,679 --> 00:37:09,399 reason this is start there is 898 00:37:08,199 --> 00:37:11,239 anticipation that this will have 899 00:37:09,400 --> 00:37:13,400 macroeconomic consequences and as a 900 00:37:11,239 --> 00:37:17,078 result of that that the FED will react 901 00:37:13,400 --> 00:37:17,079 that inflation will change and all 902 00:37:17,440 --> 00:37:21,559 that okay so that's where we were at on 903 00:37:20,119 --> 00:37:24,160 Monday remember when we had the lecture 904 00:37:21,559 --> 00:37:28,119 I was telling you more or less that 905 00:37:24,159 --> 00:37:30,000 story ER what is this 906 00:37:28,119 --> 00:37:32,358 you can read it there but it may not 907 00:37:30,000 --> 00:37:35,480 mean M to much to you but I'm what I'm 908 00:37:32,358 --> 00:37:39,639 highlighting is this this is pretty big 909 00:37:35,480 --> 00:37:41,838 huh 35% decline this is an equity it's a 910 00:37:39,639 --> 00:37:44,440 share so this is 911 00:37:41,838 --> 00:37:47,599 the the value of the 912 00:37:44,440 --> 00:37:51,920 equity of a pretty major Bank credit 913 00:37:47,599 --> 00:37:54,880 Swiss okay so credit Swiss have been in 914 00:37:51,920 --> 00:37:58,000 trouble for a while but today got into 915 00:37:54,880 --> 00:38:00,680 really big trouble okay and and and you 916 00:37:58,000 --> 00:38:02,358 saw sort of a massive collap collapse in 917 00:38:00,679 --> 00:38:04,159 the equity shares in fact they stopped 918 00:38:02,358 --> 00:38:09,480 trading for a while and so 919 00:38:04,159 --> 00:38:12,399 on this thing here is H you know I 920 00:38:09,480 --> 00:38:14,480 updated your slides many times today 921 00:38:12,400 --> 00:38:17,160 because I began to look at this event 922 00:38:14,480 --> 00:38:18,920 around here and then this thing kept 923 00:38:17,159 --> 00:38:20,879 going then they stop kept going and so 924 00:38:18,920 --> 00:38:23,519 and I I'm not sure where it's at now I 925 00:38:20,880 --> 00:38:26,559 stopped at what time did I stop 9 in the 926 00:38:23,519 --> 00:38:30,039 morning I was awake at 4:44 today so 927 00:38:26,559 --> 00:38:33,960 they tell you this was this was a pretty 928 00:38:30,039 --> 00:38:37,199 intense um but this what this is is the 929 00:38:33,960 --> 00:38:39,920 credit default swaps on a credit swis 930 00:38:37,199 --> 00:38:42,118 credit swap is whenever it's a bond 931 00:38:39,920 --> 00:38:44,838 issued by a bank you can buy an 932 00:38:42,119 --> 00:38:47,920 insurance on that Bond okay so it's so 933 00:38:44,838 --> 00:38:50,078 so if the bond defaults on you you then 934 00:38:47,920 --> 00:38:52,960 use the insurance and you get 935 00:38:50,079 --> 00:38:56,280 paid so these things for banks normally 936 00:38:52,960 --> 00:38:57,679 are very small numbers but for credit SS 937 00:38:56,280 --> 00:38:59,800 bigger than for other big Banks because 938 00:38:57,679 --> 00:39:02,440 I've been in in trouble for a while all 939 00:38:59,800 --> 00:39:03,920 sort of trouble but look at that Spike 940 00:39:02,440 --> 00:39:06,000 there I mean that's pretty big for these 941 00:39:03,920 --> 00:39:07,639 kind of things you know it's not Lon yet 942 00:39:06,000 --> 00:39:10,838 but 943 00:39:07,639 --> 00:39:13,159 big so anyway that caused a little Panic 944 00:39:10,838 --> 00:39:16,880 today 945 00:39:13,159 --> 00:39:20,159 ER this is the the stock prices of the 946 00:39:16,880 --> 00:39:23,280 main European Banks this is all today 947 00:39:20,159 --> 00:39:25,559 yeah so look at this it was a little 948 00:39:23,280 --> 00:39:28,519 rally yesterday and so on I mean this is 949 00:39:25,559 --> 00:39:31,799 this is the decline as a result of the 950 00:39:28,519 --> 00:39:34,559 US problem the Silicon Valley Banks then 951 00:39:31,800 --> 00:39:39,839 a rally yesterday and then credit Swiss 952 00:39:34,559 --> 00:39:43,679 happen and you has a big decline in h in 953 00:39:39,838 --> 00:39:46,519 in all the major banks in in Europe the 954 00:39:43,679 --> 00:39:49,239 US banks are also declining but but that 955 00:39:46,519 --> 00:39:51,880 was bigger for the major 956 00:39:49,239 --> 00:39:54,318 Banks the vix remember I told you last 957 00:39:51,880 --> 00:39:56,640 last week last Monday about this 958 00:39:54,318 --> 00:39:58,358 indicator of fear in the market which is 959 00:39:56,639 --> 00:40:01,358 really the price put options I'm 960 00:39:58,358 --> 00:40:04,799 simplifying things I mean protection for 961 00:40:01,358 --> 00:40:08,159 for big declines on the equity Market H 962 00:40:04,800 --> 00:40:10,800 again it began to spike very very 963 00:40:08,159 --> 00:40:12,879 sharply as a result of this is what 964 00:40:10,800 --> 00:40:15,079 happened with the US event then 965 00:40:12,880 --> 00:40:18,880 yesterday we got a rally Rison type 966 00:40:15,079 --> 00:40:22,280 thing and then today we got a new 967 00:40:18,880 --> 00:40:24,720 event look at this I like this 968 00:40:22,280 --> 00:40:28,000 picture what this is let me let me tell 969 00:40:24,719 --> 00:40:32,519 you what the the the the the blue line 970 00:40:28,000 --> 00:40:35,559 is the blue line is is the 971 00:40:32,519 --> 00:40:38,599 market ER 972 00:40:35,559 --> 00:40:42,358 expected federal funds rate at different 973 00:40:38,599 --> 00:40:44,800 days in the future okay so you know 974 00:40:42,358 --> 00:40:47,920 today the federal funds rate is is is 975 00:40:44,800 --> 00:40:51,280 around four and a half and this is what 976 00:40:47,920 --> 00:40:53,599 what the market expects okay so they 977 00:40:51,280 --> 00:40:56,319 expected so they expected the FED to 978 00:40:53,599 --> 00:40:58,280 continue to hike interest rate and to 979 00:40:56,318 --> 00:41:02,119 reach a peak 980 00:40:58,280 --> 00:41:05,560 ER around in June 14th in that meeting 981 00:41:02,119 --> 00:41:07,720 of the order of five five 5.3% or so 982 00:41:05,559 --> 00:41:09,159 that's that's what the average there 983 00:41:07,719 --> 00:41:11,879 lots of dispersion there people betting 984 00:41:09,159 --> 00:41:14,000 on 6% but that's the average that's what 985 00:41:11,880 --> 00:41:16,280 people expected the yellow thinks it's 986 00:41:14,000 --> 00:41:18,358 the number of hikes that you're likely 987 00:41:16,280 --> 00:41:20,519 to see so you know you're likely to see 988 00:41:18,358 --> 00:41:22,480 one hike in the next meeting another one 989 00:41:20,519 --> 00:41:26,079 in the next meeting and another one in 990 00:41:22,480 --> 00:41:28,318 the next meeting and then stop and begin 991 00:41:26,079 --> 00:41:31,720 sort of cutting rates that's expect that 992 00:41:28,318 --> 00:41:33,559 was expected path on Friday 10th was 993 00:41:31,719 --> 00:41:35,799 Friday more or less around there maybe 994 00:41:33,559 --> 00:41:38,719 Thursday I don't remember but anyway 995 00:41:35,800 --> 00:41:42,800 that was expected path you see so still 996 00:41:38,719 --> 00:41:45,118 hike rates reach a peak of five 5.3% and 997 00:41:42,800 --> 00:41:48,400 still sort of pretty high interest rates 998 00:41:45,119 --> 00:41:50,880 by the end of the year okay that was 999 00:41:48,400 --> 00:41:50,880 expected 1000 00:41:51,280 --> 00:41:58,240 path that's the way it looks 1001 00:41:54,599 --> 00:42:00,039 now very different no now 1002 00:41:58,239 --> 00:42:02,199 people are expecting very small changes 1003 00:42:00,039 --> 00:42:05,880 now I show you it's like 13 basis points 1004 00:42:02,199 --> 00:42:09,639 what people expect okay the still people 1005 00:42:05,880 --> 00:42:12,880 expect sort of a hike but but small one 1006 00:42:09,639 --> 00:42:15,559 now they expect a peak to be sort of in 1007 00:42:12,880 --> 00:42:17,599 May and then the FED to start cutting 1008 00:42:15,559 --> 00:42:20,639 very aggressively to at the end of the 1009 00:42:17,599 --> 00:42:22,240 year end up with much lower rates than 1010 00:42:20,639 --> 00:42:24,719 today 1011 00:42:22,239 --> 00:42:25,879 okay so this is exactly what I was 1012 00:42:24,719 --> 00:42:28,358 telling you before the market is 1013 00:42:25,880 --> 00:42:31,880 anticipating that that we had a huge 1014 00:42:28,358 --> 00:42:35,440 contraction in the is because X went up 1015 00:42:31,880 --> 00:42:37,800 a lot ER the immediate consequences 1016 00:42:35,440 --> 00:42:39,679 that's going to be lower inflation yes 1017 00:42:37,800 --> 00:42:42,839 we have a problem because I mean if if 1018 00:42:39,679 --> 00:42:44,838 the US did not have a 5 and a half% of 1019 00:42:42,838 --> 00:42:47,318 inflation 1020 00:42:44,838 --> 00:42:48,599 today I can assure you that the FED 1021 00:42:47,318 --> 00:42:51,400 would have come out and said we cut the 1022 00:42:48,599 --> 00:42:53,480 rates right now the only reason they're 1023 00:42:51,400 --> 00:42:55,838 not cutting right now is because we have 1024 00:42:53,480 --> 00:42:57,400 a two problems we have the the financial 1025 00:42:55,838 --> 00:42:59,078 Panic on one side and we have the High 1026 00:42:57,400 --> 00:43:00,800 inflation on the other side so so they 1027 00:42:59,079 --> 00:43:03,440 have to balance these two 1028 00:43:00,800 --> 00:43:05,160 forces but but the expectation of the 1029 00:43:03,440 --> 00:43:06,760 market is that the balance of two forces 1030 00:43:05,159 --> 00:43:09,519 going to be dominated by the contraction 1031 00:43:06,760 --> 00:43:11,599 and aggregate demand much sooner than 1032 00:43:09,519 --> 00:43:13,559 people were expecting okay so that's 1033 00:43:11,599 --> 00:43:15,000 what the market is pricing at the moment 1034 00:43:13,559 --> 00:43:16,319 and what I'm saying is I was trying to 1035 00:43:15,000 --> 00:43:19,838 highlight is that this is very 1036 00:43:16,318 --> 00:43:19,838 consistent with 1037 00:43:21,400 --> 00:43:27,000 h with that okay it's just the market 1038 00:43:25,199 --> 00:43:29,759 looking ahead of what it's likely to 1039 00:43:27,000 --> 00:43:31,318 Happ happen it started from a situation 1040 00:43:29,760 --> 00:43:32,920 which is a little bit more complicated 1041 00:43:31,318 --> 00:43:35,920 again because we already had high 1042 00:43:32,920 --> 00:43:39,480 inflation well I do not know really I 1043 00:43:35,920 --> 00:43:41,880 mean it is on one end more complicated 1044 00:43:39,480 --> 00:43:45,559 because we have a problem of high 1045 00:43:41,880 --> 00:43:47,039 inflation on the other hand having high 1046 00:43:45,559 --> 00:43:48,839 inflation allows you to cut the real 1047 00:43:47,039 --> 00:43:50,079 interest rate much more aggressively 1048 00:43:48,838 --> 00:43:51,279 because if you bring the nominal 1049 00:43:50,079 --> 00:43:53,800 interest rate to zero and you have 1050 00:43:51,280 --> 00:43:56,280 inflation of 5% that allows you to cut 1051 00:43:53,800 --> 00:43:57,680 the real interest rate to minus 5% well 1052 00:43:56,280 --> 00:44:00,079 if you start with a situation where your 1053 00:43:57,679 --> 00:44:02,719 inflation is zero you don't have any 1054 00:44:00,079 --> 00:44:04,559 space to cut the real interest rate so 1055 00:44:02,719 --> 00:44:06,159 the FED can be very aggressive here and 1056 00:44:04,559 --> 00:44:07,760 the only reason is not being very very 1057 00:44:06,159 --> 00:44:09,399 aggressive they were very aggressive in 1058 00:44:07,760 --> 00:44:13,920 terms of supporting deposits and all 1059 00:44:09,400 --> 00:44:15,280 that but the the the the the they can be 1060 00:44:13,920 --> 00:44:17,639 very aggressive in terms of interest 1061 00:44:15,280 --> 00:44:19,880 rate cut if the need arises hopefully 1062 00:44:17,639 --> 00:44:21,639 won't but but they have a space because 1063 00:44:19,880 --> 00:44:22,960 we're starting from a much higher level 1064 00:44:21,639 --> 00:44:25,318 of inflation that 1065 00:44:22,960 --> 00:44:28,119 helps it it hurts in the sense that it 1066 00:44:25,318 --> 00:44:30,039 will delay the reaction but it helps in 1067 00:44:28,119 --> 00:44:32,920 the sense that they have much more space 1068 00:44:30,039 --> 00:44:32,920 for for 1069 00:44:34,800 --> 00:44:38,200 policy what is 1070 00:44:39,519 --> 00:44:45,880 this oh this is just interest one year 1071 00:44:42,239 --> 00:44:47,959 interest rates okay that that reflects 1072 00:44:45,880 --> 00:44:52,358 the the the previous picture as well 1073 00:44:47,960 --> 00:44:53,440 people you know one year out rates were 1074 00:44:52,358 --> 00:44:57,558 over 1075 00:44:53,440 --> 00:44:58,800 5% uh a few days ago and now are in the 1076 00:44:57,559 --> 00:45:01,400 low 1077 00:44:58,800 --> 00:45:06,160 force and this picture I kept updating 1078 00:45:01,400 --> 00:45:06,160 as you can see it was really dropping 1079 00:45:06,440 --> 00:45:13,880 fast that's a big change me look the one 1080 00:45:09,400 --> 00:45:13,880 year rate 60 basis points that's a big 1081 00:45:14,880 --> 00:45:19,720 change so that's where we're 1082 00:45:17,440 --> 00:45:21,358 at I'm from the next lecture I want to 1083 00:45:19,719 --> 00:45:24,519 start with growth but any questions 1084 00:45:21,358 --> 00:45:24,519 about this or 1085 00:45:25,119 --> 00:45:30,480 no okay I don't want to start growth now 1086 00:45:27,719 --> 00:45:31,679 in four minutes but uh so the set of 1087 00:45:30,480 --> 00:45:33,800 topics we're going to discuss from the 1088 00:45:31,679 --> 00:45:36,799 next lecture are very 1089 00:45:33,800 --> 00:45:38,720 different ER subject to not having any 1090 00:45:36,800 --> 00:45:40,920 major events if there is a major major 1091 00:45:38,719 --> 00:45:43,399 event I'm going to reffle things so we 1092 00:45:40,920 --> 00:45:45,318 can talk about financial panics and 1093 00:45:43,400 --> 00:45:47,720 things of that kind let's hope that it 1094 00:45:45,318 --> 00:45:51,480 can stick to the program and do 1095 00:45:47,719 --> 00:45:55,118 growth in the in the next week okay good 1096 00:45:51,480 --> 00:45:55,119 or would we do