let me um continue with the eslm PC
model in fact I want to I Rush a little
because I was over excited with the svb
bank event H and and I want to make sure
that you
certainly understand this this mle it's
going to be very
important and I think it's one of the
most important moles in in this course
as I said
before also I want to use a little bit
more the this Mo itself to explain what
is going on right now today we got hit
by a second shock from the financial
system and uh so so it's getting it's
getting exciting these days so let me
skip all this and remind you that that's
what we we that's that's the ISL MPC
model which I said is nothing else and
just integrating the islm analysis with
the Philips curve this is the part and I
said and at this point I will follow the
book and and assume that the central
bank can control the real interest rate
rather than the nominal interest rate
which is what really controls in
practice H but I'm going to make that
assumption so the pictures have less
curves moving around when when things
are mov moving H as when we do Dynamics
okay but that's just a eslm nothing
different um then we look at the Philips
curve and I said well we can we can uh I
this is not very useful because you know
in the as part I have output here and in
the Philips curves I have inflation but
then I have an employment and I don't
want to be carrying around sort of three
variables endogenous variables
ER and and and so it's you know it's
difficult to diagrams in in three
dimension is everything less clear so
I'm going to replace H this unemployment
here for for output and it's very easy
to do that with the production function
we have because output is just equal to
employment and employment is just equal
to the labor force time one minus the
rate of unemployment and we could Define
a concept of potential output as simply
that output that happens when employment
is equal to the Natural level of
employment which is equal to the labor
force Time 1 minus the natural rate of
unemployment and taking the difference
subtracting the second line from the
first one you get a concept that is used
very frequently in microeconomics which
is called is a concept of the output gap
an output Gap refers to the difference
between actual output and potential
output in which potential output is
nothing else of the level of output that
you get when employment when an
employment is at the natural rate of an
employment
so we get this output Gap is related to
the employment gap and now we can
replace the employment gap from here
with the output Gap and we end up with a
Philip Cur in the space of inflation and
output gap which is something we can
integrate very easily withm model that
has output in it okay so that's H so the
snpc model is
really combining this equation with that
equation and some model about expected
inflation that's what the MPC model is
so I gave you one example here one model
of inflation this is a case of that
central banks do not like the an Anor
unanchor inflation expectation that's my
model of expectation then my Philips
curve I plug this into my Philips curve
and I get this relationship between the
change in inflation and the output Gap
and it's an increasing relationship and
that's what I'm plotting here for any
given
level for any given level of YN then as
a increase output the Philips curve the
change in inflation the left hand side
the difference between inflation expect
to inflation Rises that's the reason
this upward is sloping and the reason
this Rises has to do with all the things
that happen in the labor market no if an
employment if output Rises meaning an
employment is falling you need more
employment to produce more output if
that's the case it's more wage pressure
that leads to a price pressure because
there is a the market in between wages
and prices and that's the way you get
into inflation okay so I gave you one
example says okay
suppose that we have some equilibrium
level of output this which is the result
of this monetary policy this rate set by
by by the central bank and and that's
the is which is a function of you know
the fiscal policy of the country how
confident are consumers and all these
kind of things so in quiz one we really
worry only about this top diagram okay
and all the shocks we had were shocks
that happen in this top diagram and we
and we look at what happened to Output
to equilibrium output as a
result now this hasn't changed it hasn't
change that block is the same as it used
to be the only difference that we have
here is that this level of output H
which is the equilibrium level of output
at any point in time needs not be equal
to potential output and if it is not
equal to potential output that will lead
to something with inflation either
inflation disinflation or something of
that kind in this particular case the
equilibrium level of output which is
still determined as we used to determine
it happens to be higher than the natural
rate of
output and if if output is higher than
the rate of output that means this is
positive which means inflation is rising
and that's exactly what we see here it
means inflation is above expected
inflation when expected inflation is
equal to lag inflation
then that means inflation is rising okay
and that's what we have
here so any question about that so this
is we just what we did is kept analysis
we used to have and now we added this
diagram here at the bottom because it
turns out that yes any equilibrium here
if I move the inter around I'm going to
change the equilibrium level of output
those all those are equilibrium levels
output but that doesn't mean that that
they're consistent with the natural ER H
with potential output and if it's not
equal to potential output it's a valid
equilibrium at any point in time but
it's going to lead to issues on the
inflation front that's all that the the
second diagram here tells you that we
get issues on the inflation front with
any equilibrium level of output that is
different from the natural rate of
output that's what this diagram
does so then I said well and that's what
happen in the short run that's what it
does so we keep doing what we used to do
in the first seven lectures or so and uh
this diagram just tells us what are the
implications for inflation that's in the
short run the medium run we said is when
we is that process in which output
converges back to the Natural rate to
potential output how does that happen
well it involves the central bank but
it's not that the central bank is doing
crazyy things effect Central Bank is
reacting to what the economy is telling
it needs to do here is a central bank
that supposed had
was before doing whatever change in the
interest rate or in the deliver this
equilibrium output here had an inflation
of around 2% that was consistent with
the target it had now suddenly it finds
itself in a situation like this and
inflation starts climbing okay you get
3% one year 4% the next one 6 nine in a
situation like that well it's very
natural for that Central Bank if it's a
responsible Central Bank to react to
that and the only reaction a central
bank can have
the main the main reaction can have is
to raise interest rates okay and that's
exactly what it starts happening if the
Central Bank finds itself with inflation
in this Cas is that is accelerating it
will start increasing interest rate and
this process of acceleration of
inflation in this case would only stop
when output is equal to the Natural to
potential output okay and output is
equal we can Define implicitly what that
interest rate is and we can call it the
natural rate of interest rate sometimes
we call it we sell
interest rate of interest rate neutral
interest rate R star lots of names for
this interest rate but this interest is
simply the one that gives us an
equilibrium output in our asln diagram
that is equal to potential output that's
that's all that this RN means and here
I'm solving it you know it's is the rate
that implicitly gives us an equilibrium
output here H that is equal to the
Natural rate of output okay that defines
it implicitly
okay there we are is all that
clear yes okay I think you're going to
have a a big chunk of your current pie
set is about this model and so on and
and that's a good thing and you'll see
it also in the next one this again I
think this is important then I talk
about the difference between anchor and
an anchor expectations I said look here
we have a situation that suppose we
started at 2% and then we found ourself
in a situation like that that means
inflation start building up we got to 9%
or so so now the FED gets scared and it
starts raising interest rates so that's
what we're moving up lower in output and
as it lowers output reduces the output
Gap and therefore reduces the change in
inflation here but inflation keeps
rising in this particular model because
expected inflation is an anchor and I
said well suppose that eventually the
FED gets to that interest rate here so
we get to situation like that and I
asked the question has the FED solved
the problem now okay finally we got to
situation where the the interest rate is
equal to an natural rate of interest
rate that tells me that output is equal
to potential output that tells me here
that inflation is not changing problem
is that we already had inflation of 9%
at some point so so here inflation stops
rising in this particular model with
expected inflation an anchor expected
inflation but stopping is not enough
because that's gives leaves us level of
inflation of
9% that means that the FED in order to
bring back inflation to 2% it needs to
go into this region so inflation starts
coming down from 9% 7% 6% 5% and so on
okay so if you have an anchor
expectation and and inflation overshoots
you're going to have to cause a
recession and probably a severe
recession there's no way around that and
that's what the FED has been struggling
to do is is struggling not to because
the Fed we are in a situation not only
in the US but in the US in particular
where inflation is way above the target
level H but expected inflation has been
more or less stable and so this when
people talk about being able to restore
sort of reasonable levels of inflation
in a soft landed manner with a soft
Landing that means that you don't need
to cost a b recession to bring inflation
back to 2% you just can bring it
smoothly here with this model of
expected inflation doesn't work but if
expect if the Bank Central Bank has
credibility H and inflation remain Anor
people continue to believe that the FED
will go back to 2% then you don't need
to cause a big recession otherwise you
need to invest in bringing expectations
down and that the only way you can
invest in doing that is causing a
recession okay but that's the reason I
said central banks worry so much about
keeping inflation credibility because
otherwise they need to
overshoot in order to restore um long
run balance
okay
good
now you may Wonder well this I mean this
looks pretty simple to do no just if you
have a problem like this just go quickly
to that point there no and then the
problem is over you don't let inflation
build to 9% or something like that you
react immediately the problem is there's
a f sentence that was going by Milton
fredman is that monetary policy acts on
the economy with long and variable lags
so first of all it's very difficult at
any point in time to know where is
potential output or what is the natural
rate of unemployment I mean you sort of
sense it but the truth is that the only
way you really know is is by looking at
inflation so it's inflation that really
tells you that you're one side of the
other it's very difficult to you you
have some historical average and so on
but these things do move move around so
it's difficult at any point in time to
know whether you you are at our end or
not the second thing is that here
everything happens immediately if I move
immediately then output immediately
jumps here that's not the way monetary
policy operates in practice it takes
time for monetary policy to to to affect
the economy and so this the situation
that happened I I would say until last
week was the FED knew that the inflation
was still to too high but it but it also
knew that it had done a lot he had hiked
rates very aggressively by a lot and
since there are lags between the the
increasing interest rate and and the
declining output the fed's concern was
well it's clear that I still have
inflation but it may well be the case
that when this thing finally hits the
economy it hits us too much and we end
up in a recession and an unwanted
recession that was a concern okay H now
with what is happening right now there's
a little bit of a concern that we got to
that point because things were very slow
for a variety of reasons but now
something broke and the question is now
that something has broken well will we
sort of decelerate the economy very very
fast and that's a concern that's what is
happening right now okay but that's what
makes monetary policy much more
difficult than this little diagram is
that you you have all this lags these
uncertainties and all these
nonlinearities and Sly things happen
okay let me tell you when things can go
really really wrong it's not the issue
now but but we're very close to that
during the global recession Japan has
experienced several episodes like this
which is the following suppose you have
a situation where ER your inflation is
low typically these things happen in
situations where your inflation is low
and for whatever reason your natural
rate of unemployment is is
negative so you have inflation close to
zero say and then the natural rate
of interest rate is
negative what's the problem suppose you
have a zero lower
bound well if you have a zero lower
bound means that you're not going to hit
this
rate the best you can do if inflation is
around zero then you set the nominal
interest rate to zero and then the real
interest rate is around
zero well the problem is that at zero
you generate negative
inflation but if you generate negative
inflation and the nominal interest rate
is fixed at zero then now you get a
positive real interest rate because the
real interest rate is equal to the
nominal interest rate which is zero
minus inflation expected inflation but
if expected inflation or inflation is
negative minus minus is positive so that
means your real interest rate is
actually positive so your really you you
wanted something negative but you end up
with something
positive that means now you have a big
gap
here so
inflation you get into a deflation now
now inflation is very very low it gets
very negative well your real as
inflation gets more and more negative
your real interest keeps climbing so you
keep moving further and further away
from the natural rate of interest rate
that's something that is very scary for
an economy is a def deflationary trap
and that's the way you get
into deep recessions in fact that's what
happened during the Great Recession in
the
US the
no during the Great Depression in the US
okay during the Great Recession we were
close to it but we didn't get quite
there in in because lots of things were
done to prevent a repeat of the Great
Depression the one of the biggest
problems with the Great Depression ER
was that ER monetary policy was not
against the zero lower bound but it was
very slow to
react okay they were in a situation like
in this diagram
here and and but they kept the interest
rate high and they moveed very slowly
and when they tried to catch up well
they were into deflation environment so
the real interet was moving away from
them despite the fact that they were
moving the nominal interest rate down
and that you can see here so there the
Great depression starts around 1929 it
starts really in
1929 H an employment initially was low
then nominal interest rate was around 5%
and inflation rate growth declined very
rapidly in inflation rate was around
zero so you had a one year the real
interest rate was around 5% as well okay
well things got worse and employment
began to climb very rapidly and so the
FED began to lower interest rates
nominal interest rate you know it went
from 5% to 4% those were unusually low
interest rate for the time but the
problem is that the inflation by then
was minus 2 and a half% so the real
interest rate they were lowering the
nominal interest rate but the real
interest rate was rising and
unemployment accordingly was Rising as
well it kept going no look see then they
began to cut the interest rate more
aggressively okay but but we got into
real deflation minus 10% or so so the
real interest rate kept
climbing at that point was a very poor
Le time interest rate hike was a
disaster for unemployment and because it
really hied the interest rate real
interest rate even more and eventually
got got out of it with a bunch of
policies that were non monetary policies
but but
um but that's that's what happened so so
the Great Depression was very much a
story of this
kind in which essentially we get we fall
fell into depression so that interest
rate when began to climb and got the
economy deeper and deeper into recession
and employment Higher and Higher and so
on and at some point monetary policy
just didn't work so that's the reason
you have essentially do massive fiscal
policy to get out of
it let's let me talk about some of the
shocks we have discussed in the context
of this more complete model now ER and
and actually okay let me go let me talk
about sort of two canonical type shocks
you can have two broad type of shocks or
or policies in in this
Ms that you want to
analyze some of them are aggregate
demand either policies or shocks
whatever those are things that you know
aggregate demand policies move the is
curve okay the is and the LM but moves
operates in the in the in the in the
Goods Market so this is one case of a
contractionary f policy no a fiscal
consolidation so what happens here
suppose you start an equilibrium level
of output H equal to Natural rate of
output but now for whatever reason we're
running deficits that are very large you
want to reduce the size of the deficit
well you move the is to the left no you
cut government expenditure you increase
taxes that will bring output below the
natural rate of output you go to the
Philips curve here that means inflation
now you you get into deflationary forces
or inflation starts declining the result
of that so in the short run you get
exactly what we had in lecture five six
or whatever know you get a contraction
in real output but on top of that you
start getting inflation coming down or
even going negative and as a result of
that the central bank will react and it
will react and that reaction will stop
when in the long run well when output
goes back to the initial level of output
it's natural rate of output okay so the
point of this picture that is new
relative to things you already knew
is that in the short run you get very
much the type of responses we had
earlier on in the medium run that is
when now in the medium run you don't get
that a fiscal consolation does not
reduce output in the medium Run Okay a
fiscal consolation what does is reduces
the real interest rate in the in the in
the long in the medium run okay so you
see here output eventually goes back to
that level with a much lower real
interest rate and and
U the the point is sometimes this this
path this path that takes you output
down initially and then comes back can
be very painful it can take a long time
generate a recession and so on and
sometimes it can happen in easier
conditions and be faster and so on many
of the policies agreements that people
have people that understand what they're
talking about had to do with the speed
at which these things happen so
sometimes you know people can agree that
you need a fiscal consolidation but
someone think no this stuff is going to
be very slow and so I don't want to
incur in a very deep recession for very
long just to adjust a little bit the
fiscal deficit and others may think the
opposite okay it's it's mostly about the
speed but shorter response to a fiscal
consolidation or to any aggregate demand
contraction is different than the medium
ter
response and again the signals for the
central bank that it needs to move
interest rate they all come from this
block here inflation falling that tells
the Central Bank oops we may have a
problem and so on another kind of shock
that is is is is is more complicated and
that has played a role actually very
much in the recovery from covid is some
sort of supply side shock for example an
oil shock okay price of energy goes up
or something like that well that one how
do you analyze that the a supply size
shock is not something that comes from
the that we go to the slm part of the
mall a supply size shock remember we
analyze it when we did analyze the
natural rate of natural rate of
unemployment it's something that affects
the supply side of the economy we can
model that as an increase in the markup
and we know that an increase in the
markup will increase the natural rate of
unemployment that means that that that
this shock will do what to potential
output so an energy shock especially if
it's a persist one will operate like a
markup shock and that we know will
increase the natural rate of
unemployment so what happens to the to
potential
output goes down of course it's it's
know output is equal to employment to
labor force times 1 minus the natural
rate of unemployment if the natural rate
of unemployment goes up then the
potential output goes down so that is
not a shift in the top diagram it's a
shift in the lower diagram it says we
used to have this Philips curve and now
the Philips curve has shifted to the
left because we have a new natural rate
of an output and remember the natural
rate of output is that point when a ER
output equal to the Natural rate of
output doesn't produce inflationary
forces okay so what happened with this
shock here so suppose the economy was in
this equilibrium here and now it gets
hit by an oil shock
in the short run if no one reacts
nothing happens to Output doesn't move
much but what
happens you see if I don't move
something in this part of the diagram
and not move equilibrium output in the
short run equilibrium output is
determined exactly in the same way we
have determined up to now so if we get a
markup shock nothing happens to Output
if no no one no if no moves nothing
happens to help in the short but what
happens that we may not like yeah
exactly what happen is the the Philips
curve went up before that level of
output was consistent with no changes in
inflation now it's not we get an
increase in inflation so the first place
where you'll see a the effect of the of
of of the oil shock here is inflation
will pick up remember the price of
gasoline going up and all those things
well that's where you see it first
before activity Falls you see it there
that's what mess up the Philips curve
also in the 70s and 80s we going to see
lots of shocks of this kind initially
unemployment didn't move M much but
inflation keeps
climbing so that's what happens well
obviously when that happens if it's
persistent typically central banks if
they think it's very short live they're
not going to react to this stuff but if
if it is persistent and they think it's
persistent then the reaction is what
well they need to this only means that
the natural rate of
an the the natural rate of interest has
gone up no because I need to for that
same is I need to bring down equilibrium
output that means I need a higher
natural rate of interest rate or a
higher rst star so what the FED needs to
do the Central Bank needs to do is just
start increasing interest rate that's an
natural
response a lot of what happened during
the covid why inflation pick up so much
much in in Co is because we had a shock
of this kind it was not energy the
energy shock came later but it was
supply side transport transport cost and
stuff like that the network the
production Network and things like that
that broke down but they thought it was
going to be very temporary so
understanding this model they thought
okay look this this Curve will come back
come back that but by itself so better
not react right now why cause a
recession if really this Curve will come
down back down by itself well the
problem is that it didn't come back by
itself that fast some things came up
fairly fast some others did not in
particular labor for participation did
not come sufficiently fast back and so
that's the reason we stay too long in a
situation like this and that's one of
the main reasons inflation sort of creep
up in in the US and also in other places
in the world in Europe the big reason
for for why inflation picked up there is
because this curve move a lot up why is
that exactly you know they had a massive
energy shock and so that moved that
curve up a
lot
good let's I want to now return to what
is going on right
now ER oh actually first I'm going to
yeah right now meaning the last few days
so it turns out that this diagram that
that I use for the fiscal consolidation
shock can also be used to understand a
little bit what happens with
the um Silicon Valley Bank event okay
remember we model that as a credit shock
we say like like that X we had it's like
X going up well X going up that's
exactly that it moves the yes to the
left so a shock to
X to to the a panic of the kind that we
saw is like that it moves the to the
left why is
that so for any given level of the safe
real interest rate a panic a shock to
credit and so on moves the a to the left
why is
that exactly so so the real the safe
interest rate doesn't go up but but but
what goes up is is is the cost of
borrowing because you know firms need to
pay this this extra risk premium and and
then for any given safe interest rate
real interest rate firms have to pay
more which means there is less
investment for any given level of the
real interest rate and so the is moves
to the left and if that happens then you
start getting deflationary
forces okay so again all this happens
very quickly here in reality I told you
there are lots of lags and so on but
markets begin to anticipate what will
happen and
so so markets begin to anticipate so so
in the in the immediate output doesn't
collapse immediately anything and
inflation doesn't be doesn't collapse
immediately but markets realize that
there are Long Bar there lcks but but
there is a shock already so so it's
likely that these things will
happen and and and and it's likely that
this will happen and it's also likely
that the FED will react to
that what should be the reaction of the
FED if this stuff gets to be
persistent how do you get out of a shock
like that if you really want to go back
there you cut interest rates okay in the
case of the US they were hiking
interestate because we're deing with
dealing with high inflation this tells
you well you should slow down the pace
of hiking again they don't do it
immediately they meet next week but the
markets don't need to wait for the FED
they anticipate what the FED is likely
to do okay and they start betting on
that so let me show you next a bunch of
charts that show you that someone in the
market understand these mechanics okay a
lot of people because the prices are
moving exactly that
way so
this is the ER oh this is something this
is the one year ahead inflation
expectation as traded in the market it's
called inflation break even the one-ear
inflation break even so if you these
things are traded in the market and you
can trade expected inflation at all the
maturities you want so this is what the
market was expecting before this shock
you know infl we getting hotter and
hotter numbers so the economy was
inflation expected inflation as price in
the market Market was climbing okay one
year out and then the shock came and
look what happened to expect the
inflation boom it
collapse okay why is that well people
thought this shock that leads to that
okay that's what they thought this
bounce was markets got a little excited
yesterday it was a little risk on
environment today they lost all that
but but for a shock I'm going to tell
you about in a few minutes
but anyways but the point I wanted to
highlight is again expected inflation
was getting a little out of control and
then this x shock came the the Panic
shock and then immediately expected
inflation decline because people
anticipated something like this okay the
market anticipated something like that
what is
that this is the the
[Music]
um the markets expected next hike so
March 22nd the the FED will decide on
the increase in interest rate remember
the FED had decided as I said in the
previous lecture to go for a path of 50
basis points initially very high but
since a couple of meetings ago they
decided to slow down to 25 basis points
precisely because they want to wait and
see a bit what what a mess do we have I
mean there's long variable lacks they
have increased rates a lot and and so on
but so they had gone back to a pace of
25 so if you see in you know somewhere
here in in February 22nd if you ask the
market what what do you think will be
the next
hike there will be lots of answers
trades and so on but the the when I say
answers I mean what is price what is
traded this financial instrument the the
average answer was 30 basis points 30
basis point is that most of the people
thought that they were going to increase
the the interest rate by 25 basis points
and there were a few guys out there that
thought the FED doesn't increase the
interest rate by 33 basis points that's
25 50 75 okay so this 30 is meant that
almost everyone thought it was going to
be 25 but there were a few people that
were concerned that could be higher than
that what happened here we start getting
very hot numbers on inflation and so all
of a sudden the equilibrium changed
dramatically and we went to 45 which
means most people then thought in the
market that the next hike in in in on on
March 22nd was going to be 50 basis
points and a few people St stay at 25
that's the reason H this is not 0. five
but it was almost price in that point
when people say price in they're talking
about this what is the hike that price
in is this statistic look that's what
happened with
the Silicon Valley Bank event okay a
collapse in this thing now now is is
trading at around 13 basis points that
means most of the people think that the
Traders here think that there will be no
hike at all okay so a few days ago they
all thought there was going to be 50
basis point which is a big hike H and
now most people think there will be no
hike whatsoever but a few think that
it's going to be 25 me actually it's
almost 50/50 no I think today is a
little lower than that but it's almost
50/50 that is 25 or zero that's that's
what what it is but had you ask anyone
around here and certainly around here is
there any chance of zero and there would
be no one literally is that contract was
not traded okay well you see things
happen accidents happen so now that's
where where we are
at
now if this all last a week and and
everything gets resolved it doesn't have
a lot of macro iic consequences okay
it's just a little Panic you know some
people make money some people lose money
and so on but but but but this can be a
very problematic shock actually because
what you see here is that this is a size
this is Silicon Valley
Bank these are all the rest the banks
smaller than
that H it turns out that all these bank
at this moment are reshuffling their
portfolios they're becoming very
conservative because they don't want to
be exposed to similar risk they realized
the environment became very unfriendly
to you know that can be runs on banks in
any moment despite the fact that it's a
big policy package out there but people
are still withdrawing lots of deposits
from a small Banks small and Regional
Banks and they all deposi it in JP
Morgan you know the big Banks so there's
lots of deposits that despite the the
the the insurance the the the the the
blanket insurance that is implicit at
least at the moment lots of deposits
from these sectors are moving to these
major Banks here okay that's called it's
called a flight to
Quality now the problem of that for the
economy as a whole is that small Banks
and Regional Banks play a huge role in
in
lending okay I
think a little more than 50% for example
of the commercial and Industrial loans
are made by small Banks ER 80% of the
mortgages are given by a small Banks so
it so it has a big
potential consequence what I'm trying to
say is that X may stay high for quite a
bit of time okay and that's a
reason this is start there is
anticipation that this will have
macroeconomic consequences and as a
result of that that the FED will react
that inflation will change and all
that okay so that's where we were at on
Monday remember when we had the lecture
I was telling you more or less that
story ER what is this
you can read it there but it may not
mean M to much to you but I'm what I'm
highlighting is this this is pretty big
huh 35% decline this is an equity it's a
share so this is
the the value of the
equity of a pretty major Bank credit
Swiss okay so credit Swiss have been in
trouble for a while but today got into
really big trouble okay and and and you
saw sort of a massive collap collapse in
the equity shares in fact they stopped
trading for a while and so
on this thing here is H you know I
updated your slides many times today
because I began to look at this event
around here and then this thing kept
going then they stop kept going and so
and I I'm not sure where it's at now I
stopped at what time did I stop 9 in the
morning I was awake at 4:44 today so
they tell you this was this was a pretty
intense um but this what this is is the
credit default swaps on a credit swis
credit swap is whenever it's a bond
issued by a bank you can buy an
insurance on that Bond okay so it's so
so if the bond defaults on you you then
use the insurance and you get
paid so these things for banks normally
are very small numbers but for credit SS
bigger than for other big Banks because
I've been in in trouble for a while all
sort of trouble but look at that Spike
there I mean that's pretty big for these
kind of things you know it's not Lon yet
but
big so anyway that caused a little Panic
today
ER this is the the stock prices of the
main European Banks this is all today
yeah so look at this it was a little
rally yesterday and so on I mean this is
this is the decline as a result of the
US problem the Silicon Valley Banks then
a rally yesterday and then credit Swiss
happen and you has a big decline in h in
in all the major banks in in Europe the
US banks are also declining but but that
was bigger for the major
Banks the vix remember I told you last
last week last Monday about this
indicator of fear in the market which is
really the price put options I'm
simplifying things I mean protection for
for big declines on the equity Market H
again it began to spike very very
sharply as a result of this is what
happened with the US event then
yesterday we got a rally Rison type
thing and then today we got a new
event look at this I like this
picture what this is let me let me tell
you what the the the the the blue line
is the blue line is is the
market ER
expected federal funds rate at different
days in the future okay so you know
today the federal funds rate is is is
around four and a half and this is what
what the market expects okay so they
expected so they expected the FED to
continue to hike interest rate and to
reach a peak
ER around in June 14th in that meeting
of the order of five five 5.3% or so
that's that's what the average there
lots of dispersion there people betting
on 6% but that's the average that's what
people expected the yellow thinks it's
the number of hikes that you're likely
to see so you know you're likely to see
one hike in the next meeting another one
in the next meeting and another one in
the next meeting and then stop and begin
sort of cutting rates that's expect that
was expected path on Friday 10th was
Friday more or less around there maybe
Thursday I don't remember but anyway
that was expected path you see so still
hike rates reach a peak of five 5.3% and
still sort of pretty high interest rates
by the end of the year okay that was
expected
path that's the way it looks
now very different no now
people are expecting very small changes
now I show you it's like 13 basis points
what people expect okay the still people
expect sort of a hike but but small one
now they expect a peak to be sort of in
May and then the FED to start cutting
very aggressively to at the end of the
year end up with much lower rates than
today
okay so this is exactly what I was
telling you before the market is
anticipating that that we had a huge
contraction in the is because X went up
a lot ER the immediate consequences
that's going to be lower inflation yes
we have a problem because I mean if if
the US did not have a 5 and a half% of
inflation
today I can assure you that the FED
would have come out and said we cut the
rates right now the only reason they're
not cutting right now is because we have
a two problems we have the the financial
Panic on one side and we have the High
inflation on the other side so so they
have to balance these two
forces but but the expectation of the
market is that the balance of two forces
going to be dominated by the contraction
and aggregate demand much sooner than
people were expecting okay so that's
what the market is pricing at the moment
and what I'm saying is I was trying to
highlight is that this is very
consistent with
h with that okay it's just the market
looking ahead of what it's likely to
Happ happen it started from a situation
which is a little bit more complicated
again because we already had high
inflation well I do not know really I
mean it is on one end more complicated
because we have a problem of high
inflation on the other hand having high
inflation allows you to cut the real
interest rate much more aggressively
because if you bring the nominal
interest rate to zero and you have
inflation of 5% that allows you to cut
the real interest rate to minus 5% well
if you start with a situation where your
inflation is zero you don't have any
space to cut the real interest rate so
the FED can be very aggressive here and
the only reason is not being very very
aggressive they were very aggressive in
terms of supporting deposits and all
that but the the the the the they can be
very aggressive in terms of interest
rate cut if the need arises hopefully
won't but but they have a space because
we're starting from a much higher level
of inflation that
helps it it hurts in the sense that it
will delay the reaction but it helps in
the sense that they have much more space
for for
policy what is
this oh this is just interest one year
interest rates okay that that reflects
the the the previous picture as well
people you know one year out rates were
over
5% uh a few days ago and now are in the
low
force and this picture I kept updating
as you can see it was really dropping
fast that's a big change me look the one
year rate 60 basis points that's a big
change so that's where we're
at I'm from the next lecture I want to
start with growth but any questions
about this or
no okay I don't want to start growth now
in four minutes but uh so the set of
topics we're going to discuss from the
next lecture are very
different ER subject to not having any
major events if there is a major major
event I'm going to reffle things so we
can talk about financial panics and
things of that kind let's hope that it
can stick to the program and do
growth in the in the next week okay good
or would we do