WEBVTT 00:00:16.600 --> 00:00:23.199 let me um continue with the eslm PC 00:00:20.320 --> 00:00:26.118 model in fact I want to I Rush a little 00:00:23.199 --> 00:00:30.118 because I was over excited with the svb 00:00:26.118 --> 00:00:31.000 bank event H and and I want to make sure 00:00:30.118 --> 00:00:34.280 that you 00:00:31.000 --> 00:00:36.200 certainly understand this this mle it's 00:00:34.280 --> 00:00:38.280 going to be very 00:00:36.200 --> 00:00:40.840 important and I think it's one of the 00:00:38.280 --> 00:00:41.879 most important moles in in this course 00:00:40.840 --> 00:00:45.200 as I said 00:00:41.878 --> 00:00:47.238 before also I want to use a little bit 00:00:45.200 --> 00:00:49.280 more the this Mo itself to explain what 00:00:47.238 --> 00:00:51.558 is going on right now today we got hit 00:00:49.280 --> 00:00:55.359 by a second shock from the financial 00:00:51.558 --> 00:00:59.320 system and uh so so it's getting it's 00:00:55.359 --> 00:01:02.800 getting exciting these days so let me 00:00:59.320 --> 00:01:05.478 skip all this and remind you that that's 00:01:02.799 --> 00:01:08.039 what we we that's that's the ISL MPC 00:01:05.478 --> 00:01:11.118 model which I said is nothing else and 00:01:08.040 --> 00:01:13.840 just integrating the islm analysis with 00:01:11.118 --> 00:01:16.159 the Philips curve this is the part and I 00:01:13.840 --> 00:01:18.439 said and at this point I will follow the 00:01:16.159 --> 00:01:20.920 book and and assume that the central 00:01:18.438 --> 00:01:22.319 bank can control the real interest rate 00:01:20.920 --> 00:01:23.799 rather than the nominal interest rate 00:01:22.319 --> 00:01:26.118 which is what really controls in 00:01:23.799 --> 00:01:27.720 practice H but I'm going to make that 00:01:26.118 --> 00:01:29.640 assumption so the pictures have less 00:01:27.719 --> 00:01:33.280 curves moving around when when things 00:01:29.640 --> 00:01:37.439 are mov moving H as when we do Dynamics 00:01:33.280 --> 00:01:42.040 okay but that's just a eslm nothing 00:01:37.438 --> 00:01:46.239 different um then we look at the Philips 00:01:42.040 --> 00:01:48.880 curve and I said well we can we can uh I 00:01:46.239 --> 00:01:52.438 this is not very useful because you know 00:01:48.879 --> 00:01:54.399 in the as part I have output here and in 00:01:52.438 --> 00:01:55.718 the Philips curves I have inflation but 00:01:54.399 --> 00:01:57.359 then I have an employment and I don't 00:01:55.718 --> 00:02:00.640 want to be carrying around sort of three 00:01:57.359 --> 00:02:03.519 variables endogenous variables 00:02:00.640 --> 00:02:05.439 ER and and and so it's you know it's 00:02:03.519 --> 00:02:07.879 difficult to diagrams in in three 00:02:05.438 --> 00:02:11.120 dimension is everything less clear so 00:02:07.879 --> 00:02:14.199 I'm going to replace H this unemployment 00:02:11.120 --> 00:02:15.680 here for for output and it's very easy 00:02:14.199 --> 00:02:18.639 to do that with the production function 00:02:15.680 --> 00:02:21.439 we have because output is just equal to 00:02:18.639 --> 00:02:23.359 employment and employment is just equal 00:02:21.439 --> 00:02:25.719 to the labor force time one minus the 00:02:23.360 --> 00:02:28.400 rate of unemployment and we could Define 00:02:25.719 --> 00:02:30.359 a concept of potential output as simply 00:02:28.400 --> 00:02:32.840 that output that happens when employment 00:02:30.360 --> 00:02:34.519 is equal to the Natural level of 00:02:32.840 --> 00:02:37.360 employment which is equal to the labor 00:02:34.519 --> 00:02:39.599 force Time 1 minus the natural rate of 00:02:37.360 --> 00:02:41.280 unemployment and taking the difference 00:02:39.598 --> 00:02:43.560 subtracting the second line from the 00:02:41.280 --> 00:02:45.360 first one you get a concept that is used 00:02:43.560 --> 00:02:47.318 very frequently in microeconomics which 00:02:45.360 --> 00:02:49.319 is called is a concept of the output gap 00:02:47.318 --> 00:02:51.759 an output Gap refers to the difference 00:02:49.318 --> 00:02:53.399 between actual output and potential 00:02:51.759 --> 00:02:55.439 output in which potential output is 00:02:53.400 --> 00:02:57.599 nothing else of the level of output that 00:02:55.439 --> 00:02:59.479 you get when employment when an 00:02:57.598 --> 00:03:00.479 employment is at the natural rate of an 00:02:59.479 --> 00:03:02.639 employment 00:03:00.479 --> 00:03:05.199 so we get this output Gap is related to 00:03:02.639 --> 00:03:08.639 the employment gap and now we can 00:03:05.199 --> 00:03:11.560 replace the employment gap from here 00:03:08.639 --> 00:03:13.798 with the output Gap and we end up with a 00:03:11.560 --> 00:03:16.759 Philip Cur in the space of inflation and 00:03:13.799 --> 00:03:19.080 output gap which is something we can 00:03:16.759 --> 00:03:23.919 integrate very easily withm model that 00:03:19.080 --> 00:03:25.680 has output in it okay so that's H so the 00:03:23.919 --> 00:03:29.399 snpc model is 00:03:25.680 --> 00:03:31.560 really combining this equation with that 00:03:29.400 --> 00:03:35.959 equation and some model about expected 00:03:31.560 --> 00:03:38.039 inflation that's what the MPC model is 00:03:35.959 --> 00:03:40.080 so I gave you one example here one model 00:03:38.039 --> 00:03:42.479 of inflation this is a case of that 00:03:40.080 --> 00:03:45.439 central banks do not like the an Anor 00:03:42.479 --> 00:03:47.199 unanchor inflation expectation that's my 00:03:45.438 --> 00:03:50.120 model of expectation then my Philips 00:03:47.199 --> 00:03:52.119 curve I plug this into my Philips curve 00:03:50.120 --> 00:03:55.840 and I get this relationship between the 00:03:52.120 --> 00:03:57.680 change in inflation and the output Gap 00:03:55.840 --> 00:03:59.878 and it's an increasing relationship and 00:03:57.680 --> 00:04:00.920 that's what I'm plotting here for any 00:03:59.878 --> 00:04:03.840 given 00:04:00.919 --> 00:04:07.000 level for any given level of YN then as 00:04:03.840 --> 00:04:09.000 a increase output the Philips curve the 00:04:07.000 --> 00:04:10.479 change in inflation the left hand side 00:04:09.000 --> 00:04:12.919 the difference between inflation expect 00:04:10.479 --> 00:04:14.919 to inflation Rises that's the reason 00:04:12.919 --> 00:04:16.639 this upward is sloping and the reason 00:04:14.919 --> 00:04:18.879 this Rises has to do with all the things 00:04:16.639 --> 00:04:21.280 that happen in the labor market no if an 00:04:18.879 --> 00:04:23.000 employment if output Rises meaning an 00:04:21.279 --> 00:04:24.918 employment is falling you need more 00:04:23.000 --> 00:04:26.759 employment to produce more output if 00:04:24.918 --> 00:04:29.399 that's the case it's more wage pressure 00:04:26.759 --> 00:04:30.840 that leads to a price pressure because 00:04:29.399 --> 00:04:33.399 there is a the market in between wages 00:04:30.839 --> 00:04:37.359 and prices and that's the way you get 00:04:33.399 --> 00:04:40.399 into inflation okay so I gave you one 00:04:37.360 --> 00:04:42.960 example says okay 00:04:40.399 --> 00:04:45.000 suppose that we have some equilibrium 00:04:42.959 --> 00:04:48.478 level of output this which is the result 00:04:45.000 --> 00:04:52.199 of this monetary policy this rate set by 00:04:48.478 --> 00:04:54.079 by by the central bank and and that's 00:04:52.199 --> 00:04:55.840 the is which is a function of you know 00:04:54.079 --> 00:04:57.399 the fiscal policy of the country how 00:04:55.839 --> 00:05:01.079 confident are consumers and all these 00:04:57.399 --> 00:05:03.399 kind of things so in quiz one we really 00:05:01.079 --> 00:05:05.560 worry only about this top diagram okay 00:05:03.399 --> 00:05:08.038 and all the shocks we had were shocks 00:05:05.560 --> 00:05:10.120 that happen in this top diagram and we 00:05:08.038 --> 00:05:12.000 and we look at what happened to Output 00:05:10.120 --> 00:05:15.720 to equilibrium output as a 00:05:12.000 --> 00:05:17.319 result now this hasn't changed it hasn't 00:05:15.720 --> 00:05:19.560 change that block is the same as it used 00:05:17.319 --> 00:05:22.918 to be the only difference that we have 00:05:19.560 --> 00:05:24.519 here is that this level of output H 00:05:22.918 --> 00:05:26.959 which is the equilibrium level of output 00:05:24.519 --> 00:05:28.680 at any point in time needs not be equal 00:05:26.959 --> 00:05:30.680 to potential output and if it is not 00:05:28.680 --> 00:05:32.560 equal to potential output that will lead 00:05:30.680 --> 00:05:34.160 to something with inflation either 00:05:32.560 --> 00:05:37.478 inflation disinflation or something of 00:05:34.160 --> 00:05:39.199 that kind in this particular case the 00:05:37.478 --> 00:05:40.839 equilibrium level of output which is 00:05:39.199 --> 00:05:43.120 still determined as we used to determine 00:05:40.839 --> 00:05:44.279 it happens to be higher than the natural 00:05:43.120 --> 00:05:47.639 rate of 00:05:44.279 --> 00:05:50.599 output and if if output is higher than 00:05:47.639 --> 00:05:52.680 the rate of output that means this is 00:05:50.600 --> 00:05:55.160 positive which means inflation is rising 00:05:52.680 --> 00:05:56.639 and that's exactly what we see here it 00:05:55.160 --> 00:05:58.680 means inflation is above expected 00:05:56.639 --> 00:06:00.478 inflation when expected inflation is 00:05:58.680 --> 00:06:03.759 equal to lag inflation 00:06:00.478 --> 00:06:05.680 then that means inflation is rising okay 00:06:03.759 --> 00:06:08.840 and that's what we have 00:06:05.680 --> 00:06:11.720 here so any question about that so this 00:06:08.839 --> 00:06:14.079 is we just what we did is kept analysis 00:06:11.720 --> 00:06:16.240 we used to have and now we added this 00:06:14.079 --> 00:06:19.959 diagram here at the bottom because it 00:06:16.240 --> 00:06:21.319 turns out that yes any equilibrium here 00:06:19.959 --> 00:06:22.758 if I move the inter around I'm going to 00:06:21.319 --> 00:06:24.319 change the equilibrium level of output 00:06:22.759 --> 00:06:27.080 those all those are equilibrium levels 00:06:24.319 --> 00:06:29.879 output but that doesn't mean that that 00:06:27.079 --> 00:06:32.159 they're consistent with the natural ER H 00:06:29.879 --> 00:06:34.000 with potential output and if it's not 00:06:32.160 --> 00:06:35.800 equal to potential output it's a valid 00:06:34.000 --> 00:06:38.120 equilibrium at any point in time but 00:06:35.800 --> 00:06:40.720 it's going to lead to issues on the 00:06:38.120 --> 00:06:43.120 inflation front that's all that the the 00:06:40.720 --> 00:06:46.800 second diagram here tells you that we 00:06:43.120 --> 00:06:49.319 get issues on the inflation front with 00:06:46.800 --> 00:06:51.000 any equilibrium level of output that is 00:06:49.319 --> 00:06:54.720 different from the natural rate of 00:06:51.000 --> 00:06:57.038 output that's what this diagram 00:06:54.720 --> 00:06:58.360 does so then I said well and that's what 00:06:57.038 --> 00:07:00.360 happen in the short run that's what it 00:06:58.360 --> 00:07:04.120 does so we keep doing what we used to do 00:07:00.360 --> 00:07:05.960 in the first seven lectures or so and uh 00:07:04.120 --> 00:07:07.959 this diagram just tells us what are the 00:07:05.959 --> 00:07:10.918 implications for inflation that's in the 00:07:07.959 --> 00:07:13.758 short run the medium run we said is when 00:07:10.918 --> 00:07:16.439 we is that process in which output 00:07:13.759 --> 00:07:19.240 converges back to the Natural rate to 00:07:16.439 --> 00:07:22.038 potential output how does that happen 00:07:19.240 --> 00:07:23.400 well it involves the central bank but 00:07:22.038 --> 00:07:25.120 it's not that the central bank is doing 00:07:23.399 --> 00:07:27.159 crazyy things effect Central Bank is 00:07:25.120 --> 00:07:29.639 reacting to what the economy is telling 00:07:27.160 --> 00:07:31.199 it needs to do here is a central bank 00:07:29.639 --> 00:07:33.840 that supposed had 00:07:31.199 --> 00:07:36.038 was before doing whatever change in the 00:07:33.839 --> 00:07:38.198 interest rate or in the deliver this 00:07:36.038 --> 00:07:40.318 equilibrium output here had an inflation 00:07:38.199 --> 00:07:42.639 of around 2% that was consistent with 00:07:40.319 --> 00:07:44.039 the target it had now suddenly it finds 00:07:42.639 --> 00:07:47.038 itself in a situation like this and 00:07:44.038 --> 00:07:51.279 inflation starts climbing okay you get 00:07:47.038 --> 00:07:53.120 3% one year 4% the next one 6 nine in a 00:07:51.279 --> 00:07:54.758 situation like that well it's very 00:07:53.120 --> 00:07:56.639 natural for that Central Bank if it's a 00:07:54.759 --> 00:07:58.919 responsible Central Bank to react to 00:07:56.639 --> 00:08:00.120 that and the only reaction a central 00:07:58.918 --> 00:08:01.680 bank can have 00:08:00.120 --> 00:08:03.840 the main the main reaction can have is 00:08:01.680 --> 00:08:05.759 to raise interest rates okay and that's 00:08:03.839 --> 00:08:07.878 exactly what it starts happening if the 00:08:05.759 --> 00:08:10.280 Central Bank finds itself with inflation 00:08:07.879 --> 00:08:13.240 in this Cas is that is accelerating it 00:08:10.279 --> 00:08:14.799 will start increasing interest rate and 00:08:13.240 --> 00:08:17.240 this process of acceleration of 00:08:14.800 --> 00:08:19.598 inflation in this case would only stop 00:08:17.240 --> 00:08:22.240 when output is equal to the Natural to 00:08:19.598 --> 00:08:25.038 potential output okay and output is 00:08:22.240 --> 00:08:26.759 equal we can Define implicitly what that 00:08:25.038 --> 00:08:28.279 interest rate is and we can call it the 00:08:26.759 --> 00:08:30.000 natural rate of interest rate sometimes 00:08:28.279 --> 00:08:32.799 we call it we sell 00:08:30.000 --> 00:08:35.958 interest rate of interest rate neutral 00:08:32.799 --> 00:08:37.799 interest rate R star lots of names for 00:08:35.958 --> 00:08:39.000 this interest rate but this interest is 00:08:37.799 --> 00:08:41.718 simply the one that gives us an 00:08:39.000 --> 00:08:46.320 equilibrium output in our asln diagram 00:08:41.719 --> 00:08:48.240 that is equal to potential output that's 00:08:46.320 --> 00:08:51.360 that's all that this RN means and here 00:08:48.240 --> 00:08:53.159 I'm solving it you know it's is the rate 00:08:51.360 --> 00:08:55.639 that implicitly gives us an equilibrium 00:08:53.159 --> 00:08:58.159 output here H that is equal to the 00:08:55.639 --> 00:08:59.879 Natural rate of output okay that defines 00:08:58.159 --> 00:09:04.240 it implicitly 00:08:59.879 --> 00:09:07.639 okay there we are is all that 00:09:04.240 --> 00:09:09.519 clear yes okay I think you're going to 00:09:07.639 --> 00:09:12.000 have a a big chunk of your current pie 00:09:09.519 --> 00:09:13.440 set is about this model and so on and 00:09:12.000 --> 00:09:15.600 and that's a good thing and you'll see 00:09:13.440 --> 00:09:17.920 it also in the next one this again I 00:09:15.600 --> 00:09:20.320 think this is important then I talk 00:09:17.919 --> 00:09:23.919 about the difference between anchor and 00:09:20.320 --> 00:09:25.440 an anchor expectations I said look here 00:09:23.919 --> 00:09:28.000 we have a situation that suppose we 00:09:25.440 --> 00:09:30.600 started at 2% and then we found ourself 00:09:28.000 --> 00:09:33.078 in a situation like that that means 00:09:30.600 --> 00:09:35.959 inflation start building up we got to 9% 00:09:33.078 --> 00:09:37.719 or so so now the FED gets scared and it 00:09:35.958 --> 00:09:39.679 starts raising interest rates so that's 00:09:37.720 --> 00:09:41.879 what we're moving up lower in output and 00:09:39.679 --> 00:09:45.359 as it lowers output reduces the output 00:09:41.879 --> 00:09:47.278 Gap and therefore reduces the change in 00:09:45.360 --> 00:09:49.639 inflation here but inflation keeps 00:09:47.278 --> 00:09:52.000 rising in this particular model because 00:09:49.639 --> 00:09:53.559 expected inflation is an anchor and I 00:09:52.000 --> 00:09:56.278 said well suppose that eventually the 00:09:53.559 --> 00:09:58.479 FED gets to that interest rate here so 00:09:56.278 --> 00:10:00.519 we get to situation like that and I 00:09:58.480 --> 00:10:03.360 asked the question has the FED solved 00:10:00.519 --> 00:10:05.919 the problem now okay finally we got to 00:10:03.360 --> 00:10:07.360 situation where the the interest rate is 00:10:05.919 --> 00:10:09.360 equal to an natural rate of interest 00:10:07.360 --> 00:10:11.320 rate that tells me that output is equal 00:10:09.360 --> 00:10:14.000 to potential output that tells me here 00:10:11.320 --> 00:10:17.000 that inflation is not changing problem 00:10:14.000 --> 00:10:20.480 is that we already had inflation of 9% 00:10:17.000 --> 00:10:22.200 at some point so so here inflation stops 00:10:20.480 --> 00:10:24.480 rising in this particular model with 00:10:22.200 --> 00:10:27.440 expected inflation an anchor expected 00:10:24.480 --> 00:10:29.560 inflation but stopping is not enough 00:10:27.440 --> 00:10:30.600 because that's gives leaves us level of 00:10:29.559 --> 00:10:33.479 inflation of 00:10:30.600 --> 00:10:36.200 9% that means that the FED in order to 00:10:33.480 --> 00:10:39.240 bring back inflation to 2% it needs to 00:10:36.200 --> 00:10:44.480 go into this region so inflation starts 00:10:39.240 --> 00:10:46.839 coming down from 9% 7% 6% 5% and so on 00:10:44.480 --> 00:10:49.560 okay so if you have an anchor 00:10:46.839 --> 00:10:50.720 expectation and and inflation overshoots 00:10:49.559 --> 00:10:52.239 you're going to have to cause a 00:10:50.720 --> 00:10:55.000 recession and probably a severe 00:10:52.240 --> 00:10:56.799 recession there's no way around that and 00:10:55.000 --> 00:10:59.000 that's what the FED has been struggling 00:10:56.799 --> 00:11:01.078 to do is is struggling not to because 00:10:59.000 --> 00:11:03.559 the Fed we are in a situation not only 00:11:01.078 --> 00:11:05.559 in the US but in the US in particular 00:11:03.559 --> 00:11:08.879 where inflation is way above the target 00:11:05.559 --> 00:11:11.679 level H but expected inflation has been 00:11:08.879 --> 00:11:14.879 more or less stable and so this when 00:11:11.679 --> 00:11:17.919 people talk about being able to restore 00:11:14.879 --> 00:11:20.399 sort of reasonable levels of inflation 00:11:17.919 --> 00:11:22.838 in a soft landed manner with a soft 00:11:20.399 --> 00:11:25.839 Landing that means that you don't need 00:11:22.839 --> 00:11:28.120 to cost a b recession to bring inflation 00:11:25.839 --> 00:11:30.079 back to 2% you just can bring it 00:11:28.120 --> 00:11:32.480 smoothly here with this model of 00:11:30.078 --> 00:11:34.759 expected inflation doesn't work but if 00:11:32.480 --> 00:11:37.360 expect if the Bank Central Bank has 00:11:34.759 --> 00:11:39.078 credibility H and inflation remain Anor 00:11:37.360 --> 00:11:41.399 people continue to believe that the FED 00:11:39.078 --> 00:11:43.439 will go back to 2% then you don't need 00:11:41.399 --> 00:11:45.839 to cause a big recession otherwise you 00:11:43.440 --> 00:11:47.320 need to invest in bringing expectations 00:11:45.839 --> 00:11:48.839 down and that the only way you can 00:11:47.320 --> 00:11:51.320 invest in doing that is causing a 00:11:48.839 --> 00:11:54.480 recession okay but that's the reason I 00:11:51.320 --> 00:11:56.399 said central banks worry so much about 00:11:54.480 --> 00:11:57.800 keeping inflation credibility because 00:11:56.399 --> 00:12:03.120 otherwise they need to 00:11:57.799 --> 00:12:05.278 overshoot in order to restore um long 00:12:03.120 --> 00:12:07.839 run balance 00:12:05.278 --> 00:12:09.838 okay 00:12:07.839 --> 00:12:12.480 good 00:12:09.839 --> 00:12:15.760 now you may Wonder well this I mean this 00:12:12.480 --> 00:12:18.480 looks pretty simple to do no just if you 00:12:15.759 --> 00:12:21.559 have a problem like this just go quickly 00:12:18.480 --> 00:12:23.800 to that point there no and then the 00:12:21.559 --> 00:12:26.359 problem is over you don't let inflation 00:12:23.799 --> 00:12:28.879 build to 9% or something like that you 00:12:26.360 --> 00:12:31.919 react immediately the problem is there's 00:12:28.879 --> 00:12:34.399 a f sentence that was going by Milton 00:12:31.919 --> 00:12:37.399 fredman is that monetary policy acts on 00:12:34.399 --> 00:12:39.919 the economy with long and variable lags 00:12:37.399 --> 00:12:41.480 so first of all it's very difficult at 00:12:39.919 --> 00:12:43.599 any point in time to know where is 00:12:41.480 --> 00:12:45.320 potential output or what is the natural 00:12:43.600 --> 00:12:47.519 rate of unemployment I mean you sort of 00:12:45.320 --> 00:12:50.040 sense it but the truth is that the only 00:12:47.519 --> 00:12:52.159 way you really know is is by looking at 00:12:50.039 --> 00:12:53.879 inflation so it's inflation that really 00:12:52.159 --> 00:12:56.360 tells you that you're one side of the 00:12:53.879 --> 00:12:58.399 other it's very difficult to you you 00:12:56.360 --> 00:13:00.240 have some historical average and so on 00:12:58.399 --> 00:13:01.639 but these things do move move around so 00:13:00.240 --> 00:13:04.959 it's difficult at any point in time to 00:13:01.639 --> 00:13:07.720 know whether you you are at our end or 00:13:04.958 --> 00:13:10.479 not the second thing is that here 00:13:07.720 --> 00:13:11.920 everything happens immediately if I move 00:13:10.480 --> 00:13:13.639 immediately then output immediately 00:13:11.919 --> 00:13:15.479 jumps here that's not the way monetary 00:13:13.639 --> 00:13:18.759 policy operates in practice it takes 00:13:15.480 --> 00:13:22.278 time for monetary policy to to to affect 00:13:18.759 --> 00:13:25.278 the economy and so this the situation 00:13:22.278 --> 00:13:28.559 that happened I I would say until last 00:13:25.278 --> 00:13:31.559 week was the FED knew that the inflation 00:13:28.559 --> 00:13:33.399 was still to too high but it but it also 00:13:31.559 --> 00:13:35.638 knew that it had done a lot he had hiked 00:13:33.399 --> 00:13:38.759 rates very aggressively by a lot and 00:13:35.639 --> 00:13:40.959 since there are lags between the the 00:13:38.759 --> 00:13:44.078 increasing interest rate and and the 00:13:40.958 --> 00:13:45.958 declining output the fed's concern was 00:13:44.078 --> 00:13:47.719 well it's clear that I still have 00:13:45.958 --> 00:13:49.198 inflation but it may well be the case 00:13:47.720 --> 00:13:51.920 that when this thing finally hits the 00:13:49.198 --> 00:13:53.758 economy it hits us too much and we end 00:13:51.919 --> 00:13:58.278 up in a recession and an unwanted 00:13:53.759 --> 00:13:59.839 recession that was a concern okay H now 00:13:58.278 --> 00:14:01.360 with what is happening right now there's 00:13:59.839 --> 00:14:03.360 a little bit of a concern that we got to 00:14:01.360 --> 00:14:05.560 that point because things were very slow 00:14:03.360 --> 00:14:08.839 for a variety of reasons but now 00:14:05.559 --> 00:14:11.078 something broke and the question is now 00:14:08.839 --> 00:14:13.199 that something has broken well will we 00:14:11.078 --> 00:14:15.399 sort of decelerate the economy very very 00:14:13.198 --> 00:14:18.439 fast and that's a concern that's what is 00:14:15.399 --> 00:14:20.600 happening right now okay but that's what 00:14:18.440 --> 00:14:21.959 makes monetary policy much more 00:14:20.600 --> 00:14:23.800 difficult than this little diagram is 00:14:21.958 --> 00:14:25.518 that you you have all this lags these 00:14:23.799 --> 00:14:30.758 uncertainties and all these 00:14:25.519 --> 00:14:30.759 nonlinearities and Sly things happen 00:14:30.879 --> 00:14:35.799 okay let me tell you when things can go 00:14:33.799 --> 00:14:38.919 really really wrong it's not the issue 00:14:35.799 --> 00:14:41.399 now but but we're very close to that 00:14:38.919 --> 00:14:43.479 during the global recession Japan has 00:14:41.399 --> 00:14:45.519 experienced several episodes like this 00:14:43.480 --> 00:14:50.440 which is the following suppose you have 00:14:45.519 --> 00:14:52.198 a situation where ER your inflation is 00:14:50.440 --> 00:14:54.800 low typically these things happen in 00:14:52.198 --> 00:14:57.278 situations where your inflation is low 00:14:54.799 --> 00:14:59.879 and for whatever reason your natural 00:14:57.278 --> 00:15:02.480 rate of unemployment is is 00:14:59.879 --> 00:15:06.000 negative so you have inflation close to 00:15:02.480 --> 00:15:08.360 zero say and then the natural rate 00:15:06.000 --> 00:15:11.078 of interest rate is 00:15:08.360 --> 00:15:12.440 negative what's the problem suppose you 00:15:11.078 --> 00:15:14.439 have a zero lower 00:15:12.440 --> 00:15:16.240 bound well if you have a zero lower 00:15:14.440 --> 00:15:17.560 bound means that you're not going to hit 00:15:16.240 --> 00:15:20.198 this 00:15:17.559 --> 00:15:21.559 rate the best you can do if inflation is 00:15:20.198 --> 00:15:23.359 around zero then you set the nominal 00:15:21.559 --> 00:15:24.958 interest rate to zero and then the real 00:15:23.360 --> 00:15:29.680 interest rate is around 00:15:24.958 --> 00:15:33.479 zero well the problem is that at zero 00:15:29.679 --> 00:15:36.078 you generate negative 00:15:33.480 --> 00:15:38.120 inflation but if you generate negative 00:15:36.078 --> 00:15:40.638 inflation and the nominal interest rate 00:15:38.120 --> 00:15:42.919 is fixed at zero then now you get a 00:15:40.639 --> 00:15:44.360 positive real interest rate because the 00:15:42.919 --> 00:15:46.318 real interest rate is equal to the 00:15:44.360 --> 00:15:49.519 nominal interest rate which is zero 00:15:46.318 --> 00:15:52.360 minus inflation expected inflation but 00:15:49.519 --> 00:15:54.799 if expected inflation or inflation is 00:15:52.360 --> 00:15:56.440 negative minus minus is positive so that 00:15:54.799 --> 00:15:59.159 means your real interest rate is 00:15:56.440 --> 00:16:00.800 actually positive so your really you you 00:15:59.159 --> 00:16:02.000 wanted something negative but you end up 00:16:00.799 --> 00:16:04.278 with something 00:16:02.000 --> 00:16:05.480 positive that means now you have a big 00:16:04.278 --> 00:16:07.600 gap 00:16:05.480 --> 00:16:10.000 here so 00:16:07.600 --> 00:16:11.879 inflation you get into a deflation now 00:16:10.000 --> 00:16:14.440 now inflation is very very low it gets 00:16:11.879 --> 00:16:16.399 very negative well your real as 00:16:14.440 --> 00:16:18.440 inflation gets more and more negative 00:16:16.399 --> 00:16:20.600 your real interest keeps climbing so you 00:16:18.440 --> 00:16:23.920 keep moving further and further away 00:16:20.600 --> 00:16:26.000 from the natural rate of interest rate 00:16:23.919 --> 00:16:29.360 that's something that is very scary for 00:16:26.000 --> 00:16:31.120 an economy is a def deflationary trap 00:16:29.360 --> 00:16:34.440 and that's the way you get 00:16:31.120 --> 00:16:36.198 into deep recessions in fact that's what 00:16:34.440 --> 00:16:36.839 happened during the Great Recession in 00:16:36.198 --> 00:16:38.559 the 00:16:36.839 --> 00:16:42.000 US the 00:16:38.559 --> 00:16:44.318 no during the Great Depression in the US 00:16:42.000 --> 00:16:46.078 okay during the Great Recession we were 00:16:44.318 --> 00:16:48.919 close to it but we didn't get quite 00:16:46.078 --> 00:16:52.838 there in in because lots of things were 00:16:48.919 --> 00:16:54.879 done to prevent a repeat of the Great 00:16:52.839 --> 00:16:57.759 Depression the one of the biggest 00:16:54.879 --> 00:17:01.078 problems with the Great Depression ER 00:16:57.759 --> 00:17:03.399 was that ER monetary policy was not 00:17:01.078 --> 00:17:04.798 against the zero lower bound but it was 00:17:03.399 --> 00:17:07.640 very slow to 00:17:04.798 --> 00:17:10.599 react okay they were in a situation like 00:17:07.640 --> 00:17:10.600 in this diagram 00:17:10.759 --> 00:17:16.078 here and and but they kept the interest 00:17:12.959 --> 00:17:18.558 rate high and they moveed very slowly 00:17:16.078 --> 00:17:20.959 and when they tried to catch up well 00:17:18.558 --> 00:17:22.639 they were into deflation environment so 00:17:20.959 --> 00:17:24.078 the real interet was moving away from 00:17:22.640 --> 00:17:26.480 them despite the fact that they were 00:17:24.078 --> 00:17:28.678 moving the nominal interest rate down 00:17:26.480 --> 00:17:31.599 and that you can see here so there the 00:17:28.679 --> 00:17:33.080 Great depression starts around 1929 it 00:17:31.599 --> 00:17:36.599 starts really in 00:17:33.079 --> 00:17:39.319 1929 H an employment initially was low 00:17:36.599 --> 00:17:41.798 then nominal interest rate was around 5% 00:17:39.319 --> 00:17:44.480 and inflation rate growth declined very 00:17:41.798 --> 00:17:47.000 rapidly in inflation rate was around 00:17:44.480 --> 00:17:50.640 zero so you had a one year the real 00:17:47.000 --> 00:17:53.759 interest rate was around 5% as well okay 00:17:50.640 --> 00:17:57.200 well things got worse and employment 00:17:53.759 --> 00:17:58.919 began to climb very rapidly and so the 00:17:57.200 --> 00:18:00.640 FED began to lower interest rates 00:17:58.919 --> 00:18:04.480 nominal interest rate you know it went 00:18:00.640 --> 00:18:06.520 from 5% to 4% those were unusually low 00:18:04.480 --> 00:18:08.759 interest rate for the time but the 00:18:06.519 --> 00:18:11.720 problem is that the inflation by then 00:18:08.759 --> 00:18:13.158 was minus 2 and a half% so the real 00:18:11.720 --> 00:18:14.480 interest rate they were lowering the 00:18:13.159 --> 00:18:16.799 nominal interest rate but the real 00:18:14.480 --> 00:18:19.519 interest rate was rising and 00:18:16.798 --> 00:18:23.079 unemployment accordingly was Rising as 00:18:19.519 --> 00:18:24.798 well it kept going no look see then they 00:18:23.079 --> 00:18:28.798 began to cut the interest rate more 00:18:24.798 --> 00:18:31.279 aggressively okay but but we got into 00:18:28.798 --> 00:18:33.158 real deflation minus 10% or so so the 00:18:31.279 --> 00:18:36.839 real interest rate kept 00:18:33.159 --> 00:18:39.760 climbing at that point was a very poor 00:18:36.839 --> 00:18:42.639 Le time interest rate hike was a 00:18:39.759 --> 00:18:44.279 disaster for unemployment and because it 00:18:42.640 --> 00:18:46.400 really hied the interest rate real 00:18:44.279 --> 00:18:48.000 interest rate even more and eventually 00:18:46.400 --> 00:18:49.880 got got out of it with a bunch of 00:18:48.000 --> 00:18:51.359 policies that were non monetary policies 00:18:49.880 --> 00:18:53.919 but but 00:18:51.359 --> 00:18:55.519 um but that's that's what happened so so 00:18:53.919 --> 00:18:57.400 the Great Depression was very much a 00:18:55.519 --> 00:19:01.079 story of this 00:18:57.400 --> 00:19:03.038 kind in which essentially we get we fall 00:19:01.079 --> 00:19:05.918 fell into depression so that interest 00:19:03.038 --> 00:19:07.679 rate when began to climb and got the 00:19:05.919 --> 00:19:09.240 economy deeper and deeper into recession 00:19:07.679 --> 00:19:11.038 and employment Higher and Higher and so 00:19:09.240 --> 00:19:13.000 on and at some point monetary policy 00:19:11.038 --> 00:19:15.319 just didn't work so that's the reason 00:19:13.000 --> 00:19:18.279 you have essentially do massive fiscal 00:19:15.319 --> 00:19:18.279 policy to get out of 00:19:19.558 --> 00:19:24.639 it let's let me talk about some of the 00:19:22.159 --> 00:19:27.679 shocks we have discussed in the context 00:19:24.640 --> 00:19:31.240 of this more complete model now ER and 00:19:27.679 --> 00:19:33.200 and actually okay let me go let me talk 00:19:31.240 --> 00:19:36.159 about sort of two canonical type shocks 00:19:33.200 --> 00:19:38.120 you can have two broad type of shocks or 00:19:36.159 --> 00:19:40.200 or policies in in this 00:19:38.119 --> 00:19:42.199 Ms that you want to 00:19:40.200 --> 00:19:44.279 analyze some of them are aggregate 00:19:42.200 --> 00:19:46.480 demand either policies or shocks 00:19:44.279 --> 00:19:48.599 whatever those are things that you know 00:19:46.480 --> 00:19:52.079 aggregate demand policies move the is 00:19:48.599 --> 00:19:54.319 curve okay the is and the LM but moves 00:19:52.079 --> 00:19:57.759 operates in the in the in the in the 00:19:54.319 --> 00:20:00.519 Goods Market so this is one case of a 00:19:57.759 --> 00:20:02.480 contractionary f policy no a fiscal 00:20:00.519 --> 00:20:04.240 consolidation so what happens here 00:20:02.480 --> 00:20:07.159 suppose you start an equilibrium level 00:20:04.240 --> 00:20:08.759 of output H equal to Natural rate of 00:20:07.159 --> 00:20:10.679 output but now for whatever reason we're 00:20:08.759 --> 00:20:13.079 running deficits that are very large you 00:20:10.679 --> 00:20:15.240 want to reduce the size of the deficit 00:20:13.079 --> 00:20:17.000 well you move the is to the left no you 00:20:15.240 --> 00:20:19.519 cut government expenditure you increase 00:20:17.000 --> 00:20:21.720 taxes that will bring output below the 00:20:19.519 --> 00:20:23.720 natural rate of output you go to the 00:20:21.720 --> 00:20:26.120 Philips curve here that means inflation 00:20:23.720 --> 00:20:29.000 now you you get into deflationary forces 00:20:26.119 --> 00:20:30.959 or inflation starts declining the result 00:20:29.000 --> 00:20:32.798 of that so in the short run you get 00:20:30.960 --> 00:20:35.120 exactly what we had in lecture five six 00:20:32.798 --> 00:20:37.279 or whatever know you get a contraction 00:20:35.119 --> 00:20:40.000 in real output but on top of that you 00:20:37.279 --> 00:20:42.480 start getting inflation coming down or 00:20:40.000 --> 00:20:45.519 even going negative and as a result of 00:20:42.480 --> 00:20:47.400 that the central bank will react and it 00:20:45.519 --> 00:20:49.599 will react and that reaction will stop 00:20:47.400 --> 00:20:52.000 when in the long run well when output 00:20:49.599 --> 00:20:54.918 goes back to the initial level of output 00:20:52.000 --> 00:20:57.319 it's natural rate of output okay so the 00:20:54.919 --> 00:20:59.280 point of this picture that is new 00:20:57.319 --> 00:21:01.240 relative to things you already knew 00:20:59.279 --> 00:21:02.798 is that in the short run you get very 00:21:01.240 --> 00:21:05.480 much the type of responses we had 00:21:02.798 --> 00:21:07.440 earlier on in the medium run that is 00:21:05.480 --> 00:21:09.079 when now in the medium run you don't get 00:21:07.440 --> 00:21:12.038 that a fiscal consolation does not 00:21:09.079 --> 00:21:14.240 reduce output in the medium Run Okay a 00:21:12.038 --> 00:21:16.079 fiscal consolation what does is reduces 00:21:14.240 --> 00:21:18.120 the real interest rate in the in the in 00:21:16.079 --> 00:21:21.359 the long in the medium run okay so you 00:21:18.119 --> 00:21:23.439 see here output eventually goes back to 00:21:21.359 --> 00:21:25.879 that level with a much lower real 00:21:23.440 --> 00:21:29.480 interest rate and and 00:21:25.880 --> 00:21:31.840 U the the point is sometimes this this 00:21:29.480 --> 00:21:33.880 path this path that takes you output 00:21:31.839 --> 00:21:36.119 down initially and then comes back can 00:21:33.880 --> 00:21:38.679 be very painful it can take a long time 00:21:36.119 --> 00:21:41.239 generate a recession and so on and 00:21:38.679 --> 00:21:43.559 sometimes it can happen in easier 00:21:41.240 --> 00:21:45.679 conditions and be faster and so on many 00:21:43.558 --> 00:21:47.879 of the policies agreements that people 00:21:45.679 --> 00:21:50.278 have people that understand what they're 00:21:47.880 --> 00:21:51.960 talking about had to do with the speed 00:21:50.278 --> 00:21:53.640 at which these things happen so 00:21:51.960 --> 00:21:55.120 sometimes you know people can agree that 00:21:53.640 --> 00:21:56.759 you need a fiscal consolidation but 00:21:55.119 --> 00:21:59.038 someone think no this stuff is going to 00:21:56.759 --> 00:22:00.679 be very slow and so I don't want to 00:21:59.038 --> 00:22:01.960 incur in a very deep recession for very 00:22:00.679 --> 00:22:04.000 long just to adjust a little bit the 00:22:01.960 --> 00:22:06.278 fiscal deficit and others may think the 00:22:04.000 --> 00:22:09.558 opposite okay it's it's mostly about the 00:22:06.278 --> 00:22:11.798 speed but shorter response to a fiscal 00:22:09.558 --> 00:22:14.558 consolidation or to any aggregate demand 00:22:11.798 --> 00:22:17.400 contraction is different than the medium 00:22:14.558 --> 00:22:17.399 ter 00:22:18.200 --> 00:22:22.558 response and again the signals for the 00:22:21.000 --> 00:22:23.839 central bank that it needs to move 00:22:22.558 --> 00:22:25.918 interest rate they all come from this 00:22:23.839 --> 00:22:28.639 block here inflation falling that tells 00:22:25.919 --> 00:22:32.038 the Central Bank oops we may have a 00:22:28.640 --> 00:22:35.759 problem and so on another kind of shock 00:22:32.038 --> 00:22:37.558 that is is is is is more complicated and 00:22:35.759 --> 00:22:39.960 that has played a role actually very 00:22:37.558 --> 00:22:43.119 much in the recovery from covid is some 00:22:39.960 --> 00:22:45.640 sort of supply side shock for example an 00:22:43.119 --> 00:22:49.199 oil shock okay price of energy goes up 00:22:45.640 --> 00:22:51.400 or something like that well that one how 00:22:49.200 --> 00:22:53.240 do you analyze that the a supply size 00:22:51.400 --> 00:22:56.360 shock is not something that comes from 00:22:53.240 --> 00:22:58.640 the that we go to the slm part of the 00:22:56.359 --> 00:23:00.240 mall a supply size shock remember we 00:22:58.640 --> 00:23:01.880 analyze it when we did analyze the 00:23:00.240 --> 00:23:03.640 natural rate of natural rate of 00:23:01.880 --> 00:23:06.120 unemployment it's something that affects 00:23:03.640 --> 00:23:09.480 the supply side of the economy we can 00:23:06.119 --> 00:23:11.119 model that as an increase in the markup 00:23:09.480 --> 00:23:14.200 and we know that an increase in the 00:23:11.119 --> 00:23:18.038 markup will increase the natural rate of 00:23:14.200 --> 00:23:22.759 unemployment that means that that that 00:23:18.038 --> 00:23:22.759 this shock will do what to potential 00:23:24.400 --> 00:23:30.840 output so an energy shock especially if 00:23:27.839 --> 00:23:34.879 it's a persist one will operate like a 00:23:30.839 --> 00:23:36.759 markup shock and that we know will 00:23:34.880 --> 00:23:39.200 increase the natural rate of 00:23:36.759 --> 00:23:41.200 unemployment so what happens to the to 00:23:39.200 --> 00:23:44.038 potential 00:23:41.200 --> 00:23:46.519 output goes down of course it's it's 00:23:44.038 --> 00:23:48.240 know output is equal to employment to 00:23:46.519 --> 00:23:49.639 labor force times 1 minus the natural 00:23:48.240 --> 00:23:51.319 rate of unemployment if the natural rate 00:23:49.640 --> 00:23:54.159 of unemployment goes up then the 00:23:51.319 --> 00:23:56.079 potential output goes down so that is 00:23:54.159 --> 00:23:58.640 not a shift in the top diagram it's a 00:23:56.079 --> 00:24:01.359 shift in the lower diagram it says we 00:23:58.640 --> 00:24:03.840 used to have this Philips curve and now 00:24:01.359 --> 00:24:06.319 the Philips curve has shifted to the 00:24:03.839 --> 00:24:08.359 left because we have a new natural rate 00:24:06.319 --> 00:24:12.960 of an output and remember the natural 00:24:08.359 --> 00:24:14.759 rate of output is that point when a ER 00:24:12.960 --> 00:24:16.759 output equal to the Natural rate of 00:24:14.759 --> 00:24:20.599 output doesn't produce inflationary 00:24:16.759 --> 00:24:22.919 forces okay so what happened with this 00:24:20.599 --> 00:24:25.678 shock here so suppose the economy was in 00:24:22.919 --> 00:24:29.240 this equilibrium here and now it gets 00:24:25.679 --> 00:24:31.240 hit by an oil shock 00:24:29.240 --> 00:24:33.960 in the short run if no one reacts 00:24:31.240 --> 00:24:37.359 nothing happens to Output doesn't move 00:24:33.960 --> 00:24:37.360 much but what 00:24:41.440 --> 00:24:45.399 happens you see if I don't move 00:24:43.919 --> 00:24:47.399 something in this part of the diagram 00:24:45.398 --> 00:24:49.000 and not move equilibrium output in the 00:24:47.398 --> 00:24:50.558 short run equilibrium output is 00:24:49.000 --> 00:24:52.919 determined exactly in the same way we 00:24:50.558 --> 00:24:56.918 have determined up to now so if we get a 00:24:52.919 --> 00:24:59.600 markup shock nothing happens to Output 00:24:56.919 --> 00:25:04.720 if no no one no if no moves nothing 00:24:59.599 --> 00:25:04.719 happens to help in the short but what 00:25:05.398 --> 00:25:11.038 happens that we may not like yeah 00:25:08.839 --> 00:25:13.959 exactly what happen is the the Philips 00:25:11.038 --> 00:25:16.919 curve went up before that level of 00:25:13.960 --> 00:25:20.240 output was consistent with no changes in 00:25:16.919 --> 00:25:22.720 inflation now it's not we get an 00:25:20.240 --> 00:25:26.038 increase in inflation so the first place 00:25:22.720 --> 00:25:28.079 where you'll see a the effect of the of 00:25:26.038 --> 00:25:29.720 of of the oil shock here is inflation 00:25:28.079 --> 00:25:31.359 will pick up remember the price of 00:25:29.720 --> 00:25:33.360 gasoline going up and all those things 00:25:31.359 --> 00:25:36.278 well that's where you see it first 00:25:33.359 --> 00:25:37.678 before activity Falls you see it there 00:25:36.278 --> 00:25:40.119 that's what mess up the Philips curve 00:25:37.679 --> 00:25:42.480 also in the 70s and 80s we going to see 00:25:40.119 --> 00:25:44.519 lots of shocks of this kind initially 00:25:42.480 --> 00:25:46.240 unemployment didn't move M much but 00:25:44.519 --> 00:25:48.558 inflation keeps 00:25:46.240 --> 00:25:50.120 climbing so that's what happens well 00:25:48.558 --> 00:25:51.879 obviously when that happens if it's 00:25:50.119 --> 00:25:53.119 persistent typically central banks if 00:25:51.880 --> 00:25:54.640 they think it's very short live they're 00:25:53.119 --> 00:25:56.798 not going to react to this stuff but if 00:25:54.640 --> 00:25:59.600 if it is persistent and they think it's 00:25:56.798 --> 00:26:02.359 persistent then the reaction is what 00:25:59.599 --> 00:26:03.519 well they need to this only means that 00:26:02.359 --> 00:26:06.359 the natural rate of 00:26:03.519 --> 00:26:08.960 an the the natural rate of interest has 00:26:06.359 --> 00:26:12.119 gone up no because I need to for that 00:26:08.960 --> 00:26:14.278 same is I need to bring down equilibrium 00:26:12.119 --> 00:26:16.639 output that means I need a higher 00:26:14.278 --> 00:26:19.119 natural rate of interest rate or a 00:26:16.640 --> 00:26:20.720 higher rst star so what the FED needs to 00:26:19.119 --> 00:26:22.558 do the Central Bank needs to do is just 00:26:20.720 --> 00:26:23.640 start increasing interest rate that's an 00:26:22.558 --> 00:26:25.798 natural 00:26:23.640 --> 00:26:28.360 response a lot of what happened during 00:26:25.798 --> 00:26:30.240 the covid why inflation pick up so much 00:26:28.359 --> 00:26:33.398 much in in Co is because we had a shock 00:26:30.240 --> 00:26:35.558 of this kind it was not energy the 00:26:33.398 --> 00:26:38.479 energy shock came later but it was 00:26:35.558 --> 00:26:40.599 supply side transport transport cost and 00:26:38.480 --> 00:26:41.960 stuff like that the network the 00:26:40.599 --> 00:26:44.759 production Network and things like that 00:26:41.960 --> 00:26:47.120 that broke down but they thought it was 00:26:44.759 --> 00:26:48.558 going to be very temporary so 00:26:47.119 --> 00:26:51.879 understanding this model they thought 00:26:48.558 --> 00:26:54.240 okay look this this Curve will come back 00:26:51.880 --> 00:26:55.799 come back that but by itself so better 00:26:54.240 --> 00:26:58.480 not react right now why cause a 00:26:55.798 --> 00:27:02.038 recession if really this Curve will come 00:26:58.480 --> 00:27:03.839 down back down by itself well the 00:27:02.038 --> 00:27:06.919 problem is that it didn't come back by 00:27:03.839 --> 00:27:09.319 itself that fast some things came up 00:27:06.919 --> 00:27:11.679 fairly fast some others did not in 00:27:09.319 --> 00:27:15.240 particular labor for participation did 00:27:11.679 --> 00:27:17.840 not come sufficiently fast back and so 00:27:15.240 --> 00:27:20.240 that's the reason we stay too long in a 00:27:17.839 --> 00:27:23.199 situation like this and that's one of 00:27:20.240 --> 00:27:25.759 the main reasons inflation sort of creep 00:27:23.200 --> 00:27:29.278 up in in the US and also in other places 00:27:25.759 --> 00:27:31.519 in the world in Europe the big reason 00:27:29.278 --> 00:27:36.240 for for why inflation picked up there is 00:27:31.519 --> 00:27:36.240 because this curve move a lot up why is 00:27:40.440 --> 00:27:45.558 that exactly you know they had a massive 00:27:43.480 --> 00:27:48.558 energy shock and so that moved that 00:27:45.558 --> 00:27:50.960 curve up a 00:27:48.558 --> 00:27:54.079 lot 00:27:50.960 --> 00:27:55.960 good let's I want to now return to what 00:27:54.079 --> 00:27:59.000 is going on right 00:27:55.960 --> 00:28:01.919 now ER oh actually first I'm going to 00:27:59.000 --> 00:28:04.359 yeah right now meaning the last few days 00:28:01.919 --> 00:28:06.360 so it turns out that this diagram that 00:28:04.359 --> 00:28:09.079 that I use for the fiscal consolidation 00:28:06.359 --> 00:28:12.000 shock can also be used to understand a 00:28:09.079 --> 00:28:16.960 little bit what happens with 00:28:12.000 --> 00:28:19.038 the um Silicon Valley Bank event okay 00:28:16.960 --> 00:28:21.200 remember we model that as a credit shock 00:28:19.038 --> 00:28:24.558 we say like like that X we had it's like 00:28:21.200 --> 00:28:26.840 X going up well X going up that's 00:28:24.558 --> 00:28:30.200 exactly that it moves the yes to the 00:28:26.839 --> 00:28:34.119 left so a shock to 00:28:30.200 --> 00:28:37.200 X to to the a panic of the kind that we 00:28:34.119 --> 00:28:38.439 saw is like that it moves the to the 00:28:37.200 --> 00:28:41.600 left why is 00:28:38.440 --> 00:28:44.360 that so for any given level of the safe 00:28:41.599 --> 00:28:47.558 real interest rate a panic a shock to 00:28:44.359 --> 00:28:49.918 credit and so on moves the a to the left 00:28:47.558 --> 00:28:49.918 why is 00:28:52.960 --> 00:28:58.440 that exactly so so the real the safe 00:28:55.640 --> 00:29:01.640 interest rate doesn't go up but but but 00:28:58.440 --> 00:29:04.240 what goes up is is is the cost of 00:29:01.640 --> 00:29:07.600 borrowing because you know firms need to 00:29:04.240 --> 00:29:09.399 pay this this extra risk premium and and 00:29:07.599 --> 00:29:12.639 then for any given safe interest rate 00:29:09.398 --> 00:29:14.398 real interest rate firms have to pay 00:29:12.640 --> 00:29:15.960 more which means there is less 00:29:14.398 --> 00:29:17.839 investment for any given level of the 00:29:15.960 --> 00:29:20.960 real interest rate and so the is moves 00:29:17.839 --> 00:29:23.038 to the left and if that happens then you 00:29:20.960 --> 00:29:27.558 start getting deflationary 00:29:23.038 --> 00:29:30.480 forces okay so again all this happens 00:29:27.558 --> 00:29:32.798 very quickly here in reality I told you 00:29:30.480 --> 00:29:35.399 there are lots of lags and so on but 00:29:32.798 --> 00:29:37.679 markets begin to anticipate what will 00:29:35.398 --> 00:29:40.798 happen and 00:29:37.679 --> 00:29:43.080 so so markets begin to anticipate so so 00:29:40.798 --> 00:29:44.918 in the in the immediate output doesn't 00:29:43.079 --> 00:29:47.000 collapse immediately anything and 00:29:44.919 --> 00:29:49.519 inflation doesn't be doesn't collapse 00:29:47.000 --> 00:29:52.440 immediately but markets realize that 00:29:49.519 --> 00:29:54.599 there are Long Bar there lcks but but 00:29:52.440 --> 00:29:56.440 there is a shock already so so it's 00:29:54.599 --> 00:29:59.480 likely that these things will 00:29:56.440 --> 00:30:01.558 happen and and and and it's likely that 00:29:59.480 --> 00:30:04.079 this will happen and it's also likely 00:30:01.558 --> 00:30:06.359 that the FED will react to 00:30:04.079 --> 00:30:09.839 that what should be the reaction of the 00:30:06.359 --> 00:30:09.839 FED if this stuff gets to be 00:30:12.000 --> 00:30:17.880 persistent how do you get out of a shock 00:30:14.278 --> 00:30:17.880 like that if you really want to go back 00:30:18.038 --> 00:30:23.720 there you cut interest rates okay in the 00:30:21.720 --> 00:30:25.200 case of the US they were hiking 00:30:23.720 --> 00:30:27.319 interestate because we're deing with 00:30:25.200 --> 00:30:29.720 dealing with high inflation this tells 00:30:27.319 --> 00:30:32.200 you well you should slow down the pace 00:30:29.720 --> 00:30:34.640 of hiking again they don't do it 00:30:32.200 --> 00:30:36.360 immediately they meet next week but the 00:30:34.640 --> 00:30:38.240 markets don't need to wait for the FED 00:30:36.359 --> 00:30:40.678 they anticipate what the FED is likely 00:30:38.240 --> 00:30:44.440 to do okay and they start betting on 00:30:40.679 --> 00:30:47.480 that so let me show you next a bunch of 00:30:44.440 --> 00:30:49.919 charts that show you that someone in the 00:30:47.480 --> 00:30:51.319 market understand these mechanics okay a 00:30:49.919 --> 00:30:55.519 lot of people because the prices are 00:30:51.319 --> 00:30:55.519 moving exactly that 00:30:56.038 --> 00:31:02.558 way so 00:30:58.558 --> 00:31:04.278 this is the ER oh this is something this 00:31:02.558 --> 00:31:06.558 is the one year ahead inflation 00:31:04.278 --> 00:31:08.440 expectation as traded in the market it's 00:31:06.558 --> 00:31:11.278 called inflation break even the one-ear 00:31:08.440 --> 00:31:12.919 inflation break even so if you these 00:31:11.278 --> 00:31:15.398 things are traded in the market and you 00:31:12.919 --> 00:31:18.600 can trade expected inflation at all the 00:31:15.398 --> 00:31:21.158 maturities you want so this is what the 00:31:18.599 --> 00:31:22.918 market was expecting before this shock 00:31:21.159 --> 00:31:24.840 you know infl we getting hotter and 00:31:22.919 --> 00:31:27.519 hotter numbers so the economy was 00:31:24.839 --> 00:31:31.158 inflation expected inflation as price in 00:31:27.519 --> 00:31:34.519 the market Market was climbing okay one 00:31:31.159 --> 00:31:35.760 year out and then the shock came and 00:31:34.519 --> 00:31:39.000 look what happened to expect the 00:31:35.759 --> 00:31:39.000 inflation boom it 00:31:39.240 --> 00:31:48.319 collapse okay why is that well people 00:31:44.079 --> 00:31:50.918 thought this shock that leads to that 00:31:48.319 --> 00:31:53.678 okay that's what they thought this 00:31:50.919 --> 00:31:55.799 bounce was markets got a little excited 00:31:53.679 --> 00:31:58.519 yesterday it was a little risk on 00:31:55.798 --> 00:32:01.480 environment today they lost all that 00:31:58.519 --> 00:32:03.399 but but for a shock I'm going to tell 00:32:01.480 --> 00:32:05.919 you about in a few minutes 00:32:03.398 --> 00:32:08.599 but anyways but the point I wanted to 00:32:05.919 --> 00:32:11.038 highlight is again expected inflation 00:32:08.599 --> 00:32:13.719 was getting a little out of control and 00:32:11.038 --> 00:32:15.519 then this x shock came the the Panic 00:32:13.720 --> 00:32:17.600 shock and then immediately expected 00:32:15.519 --> 00:32:20.880 inflation decline because people 00:32:17.599 --> 00:32:23.119 anticipated something like this okay the 00:32:20.880 --> 00:32:24.200 market anticipated something like that 00:32:23.119 --> 00:32:28.429 what is 00:32:24.200 --> 00:32:29.840 that this is the the 00:32:28.430 --> 00:32:34.200 [Music] 00:32:29.839 --> 00:32:37.079 um the markets expected next hike so 00:32:34.200 --> 00:32:39.679 March 22nd the the FED will decide on 00:32:37.079 --> 00:32:41.199 the increase in interest rate remember 00:32:39.679 --> 00:32:43.559 the FED had decided as I said in the 00:32:41.200 --> 00:32:46.038 previous lecture to go for a path of 50 00:32:43.558 --> 00:32:47.359 basis points initially very high but 00:32:46.038 --> 00:32:49.480 since a couple of meetings ago they 00:32:47.359 --> 00:32:51.398 decided to slow down to 25 basis points 00:32:49.480 --> 00:32:53.960 precisely because they want to wait and 00:32:51.398 --> 00:32:55.398 see a bit what what a mess do we have I 00:32:53.960 --> 00:32:58.278 mean there's long variable lacks they 00:32:55.398 --> 00:33:00.119 have increased rates a lot and and so on 00:32:58.278 --> 00:33:02.839 but so they had gone back to a pace of 00:33:00.119 --> 00:33:05.638 25 so if you see in you know somewhere 00:33:02.839 --> 00:33:07.638 here in in February 22nd if you ask the 00:33:05.638 --> 00:33:08.678 market what what do you think will be 00:33:07.638 --> 00:33:11.199 the next 00:33:08.679 --> 00:33:14.639 hike there will be lots of answers 00:33:11.200 --> 00:33:17.480 trades and so on but the the when I say 00:33:14.638 --> 00:33:20.319 answers I mean what is price what is 00:33:17.480 --> 00:33:23.278 traded this financial instrument the the 00:33:20.319 --> 00:33:25.558 average answer was 30 basis points 30 00:33:23.278 --> 00:33:27.079 basis point is that most of the people 00:33:25.558 --> 00:33:29.000 thought that they were going to increase 00:33:27.079 --> 00:33:30.439 the the interest rate by 25 basis points 00:33:29.000 --> 00:33:32.200 and there were a few guys out there that 00:33:30.440 --> 00:33:34.600 thought the FED doesn't increase the 00:33:32.200 --> 00:33:39.960 interest rate by 33 basis points that's 00:33:34.599 --> 00:33:41.240 25 50 75 okay so this 30 is meant that 00:33:39.960 --> 00:33:42.880 almost everyone thought it was going to 00:33:41.240 --> 00:33:44.720 be 25 but there were a few people that 00:33:42.880 --> 00:33:47.278 were concerned that could be higher than 00:33:44.720 --> 00:33:50.038 that what happened here we start getting 00:33:47.278 --> 00:33:51.599 very hot numbers on inflation and so all 00:33:50.038 --> 00:33:54.319 of a sudden the equilibrium changed 00:33:51.599 --> 00:33:56.278 dramatically and we went to 45 which 00:33:54.319 --> 00:34:00.000 means most people then thought in the 00:33:56.278 --> 00:34:02.200 market that the next hike in in in on on 00:34:00.000 --> 00:34:05.919 March 22nd was going to be 50 basis 00:34:02.200 --> 00:34:09.800 points and a few people St stay at 25 00:34:05.919 --> 00:34:12.079 that's the reason H this is not 0. five 00:34:09.800 --> 00:34:13.839 but it was almost price in that point 00:34:12.079 --> 00:34:15.919 when people say price in they're talking 00:34:13.838 --> 00:34:19.239 about this what is the hike that price 00:34:15.918 --> 00:34:21.319 in is this statistic look that's what 00:34:19.239 --> 00:34:25.319 happened with 00:34:21.320 --> 00:34:28.919 the Silicon Valley Bank event okay a 00:34:25.320 --> 00:34:31.679 collapse in this thing now now is is 00:34:28.918 --> 00:34:34.960 trading at around 13 basis points that 00:34:31.679 --> 00:34:37.639 means most of the people think that the 00:34:34.960 --> 00:34:41.639 Traders here think that there will be no 00:34:37.639 --> 00:34:43.000 hike at all okay so a few days ago they 00:34:41.639 --> 00:34:45.878 all thought there was going to be 50 00:34:43.000 --> 00:34:47.358 basis point which is a big hike H and 00:34:45.878 --> 00:34:49.519 now most people think there will be no 00:34:47.358 --> 00:34:52.078 hike whatsoever but a few think that 00:34:49.519 --> 00:34:54.719 it's going to be 25 me actually it's 00:34:52.079 --> 00:34:55.960 almost 50/50 no I think today is a 00:34:54.719 --> 00:34:59.679 little lower than that but it's almost 00:34:55.960 --> 00:35:02.320 50/50 that is 25 or zero that's that's 00:34:59.679 --> 00:35:04.679 what what it is but had you ask anyone 00:35:02.320 --> 00:35:06.559 around here and certainly around here is 00:35:04.679 --> 00:35:09.078 there any chance of zero and there would 00:35:06.559 --> 00:35:12.639 be no one literally is that contract was 00:35:09.079 --> 00:35:15.280 not traded okay well you see things 00:35:12.639 --> 00:35:17.000 happen accidents happen so now that's 00:35:15.280 --> 00:35:20.000 where where we are 00:35:17.000 --> 00:35:20.000 at 00:35:20.719 --> 00:35:26.719 now if this all last a week and and 00:35:23.800 --> 00:35:29.400 everything gets resolved it doesn't have 00:35:26.719 --> 00:35:31.118 a lot of macro iic consequences okay 00:35:29.400 --> 00:35:32.760 it's just a little Panic you know some 00:35:31.119 --> 00:35:36.720 people make money some people lose money 00:35:32.760 --> 00:35:39.800 and so on but but but but this can be a 00:35:36.719 --> 00:35:42.439 very problematic shock actually because 00:35:39.800 --> 00:35:44.200 what you see here is that this is a size 00:35:42.440 --> 00:35:46.760 this is Silicon Valley 00:35:44.199 --> 00:35:48.358 Bank these are all the rest the banks 00:35:46.760 --> 00:35:51.880 smaller than 00:35:48.358 --> 00:35:53.799 that H it turns out that all these bank 00:35:51.880 --> 00:35:55.119 at this moment are reshuffling their 00:35:53.800 --> 00:35:56.880 portfolios they're becoming very 00:35:55.119 --> 00:35:58.680 conservative because they don't want to 00:35:56.880 --> 00:36:00.640 be exposed to similar risk they realized 00:35:58.679 --> 00:36:03.039 the environment became very unfriendly 00:36:00.639 --> 00:36:05.039 to you know that can be runs on banks in 00:36:03.039 --> 00:36:06.519 any moment despite the fact that it's a 00:36:05.039 --> 00:36:08.440 big policy package out there but people 00:36:06.519 --> 00:36:10.358 are still withdrawing lots of deposits 00:36:08.440 --> 00:36:12.400 from a small Banks small and Regional 00:36:10.358 --> 00:36:14.759 Banks and they all deposi it in JP 00:36:12.400 --> 00:36:18.039 Morgan you know the big Banks so there's 00:36:14.760 --> 00:36:21.240 lots of deposits that despite the the 00:36:18.039 --> 00:36:23.000 the the insurance the the the the the 00:36:21.239 --> 00:36:24.838 blanket insurance that is implicit at 00:36:23.000 --> 00:36:26.920 least at the moment lots of deposits 00:36:24.838 --> 00:36:29.358 from these sectors are moving to these 00:36:26.920 --> 00:36:31.240 major Banks here okay that's called it's 00:36:29.358 --> 00:36:34.480 called a flight to 00:36:31.239 --> 00:36:37.598 Quality now the problem of that for the 00:36:34.480 --> 00:36:40.639 economy as a whole is that small Banks 00:36:37.599 --> 00:36:41.318 and Regional Banks play a huge role in 00:36:40.639 --> 00:36:45.400 in 00:36:41.318 --> 00:36:48.559 lending okay I 00:36:45.400 --> 00:36:50.039 think a little more than 50% for example 00:36:48.559 --> 00:36:53.799 of the commercial and Industrial loans 00:36:50.039 --> 00:36:55.920 are made by small Banks ER 80% of the 00:36:53.800 --> 00:36:58.119 mortgages are given by a small Banks so 00:36:55.920 --> 00:36:59.599 it so it has a big 00:36:58.119 --> 00:37:01.880 potential consequence what I'm trying to 00:36:59.599 --> 00:37:05.680 say is that X may stay high for quite a 00:37:01.880 --> 00:37:08.200 bit of time okay and that's a 00:37:05.679 --> 00:37:09.399 reason this is start there is 00:37:08.199 --> 00:37:11.239 anticipation that this will have 00:37:09.400 --> 00:37:13.400 macroeconomic consequences and as a 00:37:11.239 --> 00:37:17.078 result of that that the FED will react 00:37:13.400 --> 00:37:17.079 that inflation will change and all 00:37:17.440 --> 00:37:21.559 that okay so that's where we were at on 00:37:20.119 --> 00:37:24.160 Monday remember when we had the lecture 00:37:21.559 --> 00:37:28.119 I was telling you more or less that 00:37:24.159 --> 00:37:30.000 story ER what is this 00:37:28.119 --> 00:37:32.358 you can read it there but it may not 00:37:30.000 --> 00:37:35.480 mean M to much to you but I'm what I'm 00:37:32.358 --> 00:37:39.639 highlighting is this this is pretty big 00:37:35.480 --> 00:37:41.838 huh 35% decline this is an equity it's a 00:37:39.639 --> 00:37:44.440 share so this is 00:37:41.838 --> 00:37:47.599 the the value of the 00:37:44.440 --> 00:37:51.920 equity of a pretty major Bank credit 00:37:47.599 --> 00:37:54.880 Swiss okay so credit Swiss have been in 00:37:51.920 --> 00:37:58.000 trouble for a while but today got into 00:37:54.880 --> 00:38:00.680 really big trouble okay and and and you 00:37:58.000 --> 00:38:02.358 saw sort of a massive collap collapse in 00:38:00.679 --> 00:38:04.159 the equity shares in fact they stopped 00:38:02.358 --> 00:38:09.480 trading for a while and so 00:38:04.159 --> 00:38:12.399 on this thing here is H you know I 00:38:09.480 --> 00:38:14.480 updated your slides many times today 00:38:12.400 --> 00:38:17.160 because I began to look at this event 00:38:14.480 --> 00:38:18.920 around here and then this thing kept 00:38:17.159 --> 00:38:20.879 going then they stop kept going and so 00:38:18.920 --> 00:38:23.519 and I I'm not sure where it's at now I 00:38:20.880 --> 00:38:26.559 stopped at what time did I stop 9 in the 00:38:23.519 --> 00:38:30.039 morning I was awake at 4:44 today so 00:38:26.559 --> 00:38:33.960 they tell you this was this was a pretty 00:38:30.039 --> 00:38:37.199 intense um but this what this is is the 00:38:33.960 --> 00:38:39.920 credit default swaps on a credit swis 00:38:37.199 --> 00:38:42.118 credit swap is whenever it's a bond 00:38:39.920 --> 00:38:44.838 issued by a bank you can buy an 00:38:42.119 --> 00:38:47.920 insurance on that Bond okay so it's so 00:38:44.838 --> 00:38:50.078 so if the bond defaults on you you then 00:38:47.920 --> 00:38:52.960 use the insurance and you get 00:38:50.079 --> 00:38:56.280 paid so these things for banks normally 00:38:52.960 --> 00:38:57.679 are very small numbers but for credit SS 00:38:56.280 --> 00:38:59.800 bigger than for other big Banks because 00:38:57.679 --> 00:39:02.440 I've been in in trouble for a while all 00:38:59.800 --> 00:39:03.920 sort of trouble but look at that Spike 00:39:02.440 --> 00:39:06.000 there I mean that's pretty big for these 00:39:03.920 --> 00:39:07.639 kind of things you know it's not Lon yet 00:39:06.000 --> 00:39:10.838 but 00:39:07.639 --> 00:39:13.159 big so anyway that caused a little Panic 00:39:10.838 --> 00:39:16.880 today 00:39:13.159 --> 00:39:20.159 ER this is the the stock prices of the 00:39:16.880 --> 00:39:23.280 main European Banks this is all today 00:39:20.159 --> 00:39:25.559 yeah so look at this it was a little 00:39:23.280 --> 00:39:28.519 rally yesterday and so on I mean this is 00:39:25.559 --> 00:39:31.799 this is the decline as a result of the 00:39:28.519 --> 00:39:34.559 US problem the Silicon Valley Banks then 00:39:31.800 --> 00:39:39.839 a rally yesterday and then credit Swiss 00:39:34.559 --> 00:39:43.679 happen and you has a big decline in h in 00:39:39.838 --> 00:39:46.519 in all the major banks in in Europe the 00:39:43.679 --> 00:39:49.239 US banks are also declining but but that 00:39:46.519 --> 00:39:51.880 was bigger for the major 00:39:49.239 --> 00:39:54.318 Banks the vix remember I told you last 00:39:51.880 --> 00:39:56.640 last week last Monday about this 00:39:54.318 --> 00:39:58.358 indicator of fear in the market which is 00:39:56.639 --> 00:40:01.358 really the price put options I'm 00:39:58.358 --> 00:40:04.799 simplifying things I mean protection for 00:40:01.358 --> 00:40:08.159 for big declines on the equity Market H 00:40:04.800 --> 00:40:10.800 again it began to spike very very 00:40:08.159 --> 00:40:12.879 sharply as a result of this is what 00:40:10.800 --> 00:40:15.079 happened with the US event then 00:40:12.880 --> 00:40:18.880 yesterday we got a rally Rison type 00:40:15.079 --> 00:40:22.280 thing and then today we got a new 00:40:18.880 --> 00:40:24.720 event look at this I like this 00:40:22.280 --> 00:40:28.000 picture what this is let me let me tell 00:40:24.719 --> 00:40:32.519 you what the the the the the blue line 00:40:28.000 --> 00:40:35.559 is the blue line is is the 00:40:32.519 --> 00:40:38.599 market ER 00:40:35.559 --> 00:40:42.358 expected federal funds rate at different 00:40:38.599 --> 00:40:44.800 days in the future okay so you know 00:40:42.358 --> 00:40:47.920 today the federal funds rate is is is 00:40:44.800 --> 00:40:51.280 around four and a half and this is what 00:40:47.920 --> 00:40:53.599 what the market expects okay so they 00:40:51.280 --> 00:40:56.319 expected so they expected the FED to 00:40:53.599 --> 00:40:58.280 continue to hike interest rate and to 00:40:56.318 --> 00:41:02.119 reach a peak 00:40:58.280 --> 00:41:05.560 ER around in June 14th in that meeting 00:41:02.119 --> 00:41:07.720 of the order of five five 5.3% or so 00:41:05.559 --> 00:41:09.159 that's that's what the average there 00:41:07.719 --> 00:41:11.879 lots of dispersion there people betting 00:41:09.159 --> 00:41:14.000 on 6% but that's the average that's what 00:41:11.880 --> 00:41:16.280 people expected the yellow thinks it's 00:41:14.000 --> 00:41:18.358 the number of hikes that you're likely 00:41:16.280 --> 00:41:20.519 to see so you know you're likely to see 00:41:18.358 --> 00:41:22.480 one hike in the next meeting another one 00:41:20.519 --> 00:41:26.079 in the next meeting and another one in 00:41:22.480 --> 00:41:28.318 the next meeting and then stop and begin 00:41:26.079 --> 00:41:31.720 sort of cutting rates that's expect that 00:41:28.318 --> 00:41:33.559 was expected path on Friday 10th was 00:41:31.719 --> 00:41:35.799 Friday more or less around there maybe 00:41:33.559 --> 00:41:38.719 Thursday I don't remember but anyway 00:41:35.800 --> 00:41:42.800 that was expected path you see so still 00:41:38.719 --> 00:41:45.118 hike rates reach a peak of five 5.3% and 00:41:42.800 --> 00:41:48.400 still sort of pretty high interest rates 00:41:45.119 --> 00:41:50.880 by the end of the year okay that was 00:41:48.400 --> 00:41:50.880 expected 00:41:51.280 --> 00:41:58.240 path that's the way it looks 00:41:54.599 --> 00:42:00.039 now very different no now 00:41:58.239 --> 00:42:02.199 people are expecting very small changes 00:42:00.039 --> 00:42:05.880 now I show you it's like 13 basis points 00:42:02.199 --> 00:42:09.639 what people expect okay the still people 00:42:05.880 --> 00:42:12.880 expect sort of a hike but but small one 00:42:09.639 --> 00:42:15.559 now they expect a peak to be sort of in 00:42:12.880 --> 00:42:17.599 May and then the FED to start cutting 00:42:15.559 --> 00:42:20.639 very aggressively to at the end of the 00:42:17.599 --> 00:42:22.240 year end up with much lower rates than 00:42:20.639 --> 00:42:24.719 today 00:42:22.239 --> 00:42:25.879 okay so this is exactly what I was 00:42:24.719 --> 00:42:28.358 telling you before the market is 00:42:25.880 --> 00:42:31.880 anticipating that that we had a huge 00:42:28.358 --> 00:42:35.440 contraction in the is because X went up 00:42:31.880 --> 00:42:37.800 a lot ER the immediate consequences 00:42:35.440 --> 00:42:39.679 that's going to be lower inflation yes 00:42:37.800 --> 00:42:42.839 we have a problem because I mean if if 00:42:39.679 --> 00:42:44.838 the US did not have a 5 and a half% of 00:42:42.838 --> 00:42:47.318 inflation 00:42:44.838 --> 00:42:48.599 today I can assure you that the FED 00:42:47.318 --> 00:42:51.400 would have come out and said we cut the 00:42:48.599 --> 00:42:53.480 rates right now the only reason they're 00:42:51.400 --> 00:42:55.838 not cutting right now is because we have 00:42:53.480 --> 00:42:57.400 a two problems we have the the financial 00:42:55.838 --> 00:42:59.078 Panic on one side and we have the High 00:42:57.400 --> 00:43:00.800 inflation on the other side so so they 00:42:59.079 --> 00:43:03.440 have to balance these two 00:43:00.800 --> 00:43:05.160 forces but but the expectation of the 00:43:03.440 --> 00:43:06.760 market is that the balance of two forces 00:43:05.159 --> 00:43:09.519 going to be dominated by the contraction 00:43:06.760 --> 00:43:11.599 and aggregate demand much sooner than 00:43:09.519 --> 00:43:13.559 people were expecting okay so that's 00:43:11.599 --> 00:43:15.000 what the market is pricing at the moment 00:43:13.559 --> 00:43:16.319 and what I'm saying is I was trying to 00:43:15.000 --> 00:43:19.838 highlight is that this is very 00:43:16.318 --> 00:43:19.838 consistent with 00:43:21.400 --> 00:43:27.000 h with that okay it's just the market 00:43:25.199 --> 00:43:29.759 looking ahead of what it's likely to 00:43:27.000 --> 00:43:31.318 Happ happen it started from a situation 00:43:29.760 --> 00:43:32.920 which is a little bit more complicated 00:43:31.318 --> 00:43:35.920 again because we already had high 00:43:32.920 --> 00:43:39.480 inflation well I do not know really I 00:43:35.920 --> 00:43:41.880 mean it is on one end more complicated 00:43:39.480 --> 00:43:45.559 because we have a problem of high 00:43:41.880 --> 00:43:47.039 inflation on the other hand having high 00:43:45.559 --> 00:43:48.839 inflation allows you to cut the real 00:43:47.039 --> 00:43:50.079 interest rate much more aggressively 00:43:48.838 --> 00:43:51.279 because if you bring the nominal 00:43:50.079 --> 00:43:53.800 interest rate to zero and you have 00:43:51.280 --> 00:43:56.280 inflation of 5% that allows you to cut 00:43:53.800 --> 00:43:57.680 the real interest rate to minus 5% well 00:43:56.280 --> 00:44:00.079 if you start with a situation where your 00:43:57.679 --> 00:44:02.719 inflation is zero you don't have any 00:44:00.079 --> 00:44:04.559 space to cut the real interest rate so 00:44:02.719 --> 00:44:06.159 the FED can be very aggressive here and 00:44:04.559 --> 00:44:07.760 the only reason is not being very very 00:44:06.159 --> 00:44:09.399 aggressive they were very aggressive in 00:44:07.760 --> 00:44:13.920 terms of supporting deposits and all 00:44:09.400 --> 00:44:15.280 that but the the the the the they can be 00:44:13.920 --> 00:44:17.639 very aggressive in terms of interest 00:44:15.280 --> 00:44:19.880 rate cut if the need arises hopefully 00:44:17.639 --> 00:44:21.639 won't but but they have a space because 00:44:19.880 --> 00:44:22.960 we're starting from a much higher level 00:44:21.639 --> 00:44:25.318 of inflation that 00:44:22.960 --> 00:44:28.119 helps it it hurts in the sense that it 00:44:25.318 --> 00:44:30.039 will delay the reaction but it helps in 00:44:28.119 --> 00:44:32.920 the sense that they have much more space 00:44:30.039 --> 00:44:32.920 for for 00:44:34.800 --> 00:44:38.200 policy what is 00:44:39.519 --> 00:44:45.880 this oh this is just interest one year 00:44:42.239 --> 00:44:47.959 interest rates okay that that reflects 00:44:45.880 --> 00:44:52.358 the the the previous picture as well 00:44:47.960 --> 00:44:53.440 people you know one year out rates were 00:44:52.358 --> 00:44:57.558 over 00:44:53.440 --> 00:44:58.800 5% uh a few days ago and now are in the 00:44:57.559 --> 00:45:01.400 low 00:44:58.800 --> 00:45:06.160 force and this picture I kept updating 00:45:01.400 --> 00:45:06.160 as you can see it was really dropping 00:45:06.440 --> 00:45:13.880 fast that's a big change me look the one 00:45:09.400 --> 00:45:13.880 year rate 60 basis points that's a big 00:45:14.880 --> 00:45:19.720 change so that's where we're 00:45:17.440 --> 00:45:21.358 at I'm from the next lecture I want to 00:45:19.719 --> 00:45:24.519 start with growth but any questions 00:45:21.358 --> 00:45:24.519 about this or 00:45:25.119 --> 00:45:30.480 no okay I don't want to start growth now 00:45:27.719 --> 00:45:31.679 in four minutes but uh so the set of 00:45:30.480 --> 00:45:33.800 topics we're going to discuss from the 00:45:31.679 --> 00:45:36.799 next lecture are very 00:45:33.800 --> 00:45:38.720 different ER subject to not having any 00:45:36.800 --> 00:45:40.920 major events if there is a major major 00:45:38.719 --> 00:45:43.399 event I'm going to reffle things so we 00:45:40.920 --> 00:45:45.318 can talk about financial panics and 00:45:43.400 --> 00:45:47.720 things of that kind let's hope that it 00:45:45.318 --> 00:45:51.480 can stick to the program and do 00:45:47.719 --> 00:45:55.118 growth in the in the next week okay good 00:45:51.480 --> 00:45:55.119 or would we do