WEBVTT 00:00:00.000 --> 00:00:02.494 align:middle line:90% 00:00:02.494 --> 00:00:02.994 align:middle line:90% [SQUEAKING] 00:00:02.994 --> 00:00:03.992 align:middle line:90% [RUSTLING] 00:00:03.992 --> 00:00:06.487 align:middle line:90% [CLICKING] 00:00:06.487 --> 00:00:18.282 align:middle line:90% 00:00:18.282 --> 00:00:19.740 align:middle line:84% RICARDO CABALLERO: So remember what 00:00:19.740 --> 00:00:22.680 align:middle line:84% has been happening to the US economy. 00:00:22.680 --> 00:00:25.830 align:middle line:84% As economy-- and it happens similarly 00:00:25.830 --> 00:00:29.340 align:middle line:84% with a few lags and leads and differences 00:00:29.340 --> 00:00:31.560 align:middle line:84% in sizes but around the world, in most economies 00:00:31.560 --> 00:00:36.360 align:middle line:84% around the world, as the economy began to reopen from COVID, 00:00:36.360 --> 00:00:40.450 align:middle line:84% we had a situation where we had too much demand for supply. 00:00:40.450 --> 00:00:43.100 align:middle line:84% The potential output, using the terminology 00:00:43.100 --> 00:00:45.990 align:middle line:84% you have in the IS-LM-PC model, it 00:00:45.990 --> 00:00:48.390 align:middle line:84% was slow in picking up because we still 00:00:48.390 --> 00:00:50.850 align:middle line:84% had lots of bottlenecks in the supply chains, 00:00:50.850 --> 00:00:54.450 align:middle line:84% and in different sectors of the economy, 00:00:54.450 --> 00:00:58.470 align:middle line:84% some people didn't want to come back to work, to the labor 00:00:58.470 --> 00:01:01.350 align:middle line:90% force for a while and so on. 00:01:01.350 --> 00:01:05.400 align:middle line:84% So the supply side was very still impaired. 00:01:05.400 --> 00:01:09.150 align:middle line:84% Not as impaired as in the middle of the COVID in 2020, 00:01:09.150 --> 00:01:13.500 align:middle line:84% say, but it's still impaired, while demand 00:01:13.500 --> 00:01:18.470 align:middle line:84% was very strong because people were fed up of staying at home. 00:01:18.470 --> 00:01:21.970 align:middle line:84% They had saved a lot during the COVID recession 00:01:21.970 --> 00:01:23.450 align:middle line:90% and they wanted to spend. 00:01:23.450 --> 00:01:23.950 align:middle line:90% OK? 00:01:23.950 --> 00:01:26.050 align:middle line:84% And there had been lots of fiscal support 00:01:26.050 --> 00:01:27.890 align:middle line:84% and monetary policy support and so on, 00:01:27.890 --> 00:01:30.640 align:middle line:84% so people feel wealthy and felt rich 00:01:30.640 --> 00:01:32.290 align:middle line:90% and so they wanted to spend. 00:01:32.290 --> 00:01:34.840 align:middle line:90% 00:01:34.840 --> 00:01:37.570 align:middle line:84% There is a big demand, but supply is not there. 00:01:37.570 --> 00:01:40.690 align:middle line:84% That starts introducing inflationary pressures. 00:01:40.690 --> 00:01:44.200 align:middle line:84% Say we have a negative output-- a positive output gap, 00:01:44.200 --> 00:01:45.850 align:middle line:90% output above potential output. 00:01:45.850 --> 00:01:48.100 align:middle line:84% That puts immediate inflationary pressure. 00:01:48.100 --> 00:01:51.130 align:middle line:84% That's what we learned from the Phillips curve and all that. 00:01:51.130 --> 00:01:52.600 align:middle line:90% OK? 00:01:52.600 --> 00:01:57.430 align:middle line:84% And now for a while, the Fed did not 00:01:57.430 --> 00:02:00.070 align:middle line:84% want to react to this because they thought that this was going 00:02:00.070 --> 00:02:02.470 align:middle line:84% to be mostly a temporary phenomenon, that supply would 00:02:02.470 --> 00:02:06.250 align:middle line:84% recover pretty rapidly, and that people would, 00:02:06.250 --> 00:02:07.810 align:middle line:84% after taking one trip, well, they 00:02:07.810 --> 00:02:09.729 align:middle line:84% wouldn't want to take a second one. 00:02:09.729 --> 00:02:12.080 align:middle line:84% Fiscal support was winding down and so on, 00:02:12.080 --> 00:02:13.780 align:middle line:84% so they thought this would go away, 00:02:13.780 --> 00:02:16.000 align:middle line:84% and they didn't want to cool off the economy 00:02:16.000 --> 00:02:19.330 align:middle line:84% because they thought they didn't want to fight a temporary fight. 00:02:19.330 --> 00:02:22.450 align:middle line:84% Now as a result of new shocks, the war and things 00:02:22.450 --> 00:02:26.350 align:middle line:84% like that, but also that the initial call was not right, 00:02:26.350 --> 00:02:30.040 align:middle line:84% was incorrect, that there was a lot of inertia in demand 00:02:30.040 --> 00:02:35.080 align:middle line:84% and that pick-up in demand lasted a lot longer than they 00:02:35.080 --> 00:02:36.610 align:middle line:90% expected. 00:02:36.610 --> 00:02:39.880 align:middle line:84% Is that inflation really began to rise, 00:02:39.880 --> 00:02:45.410 align:middle line:84% and the Fed was really caught what is called behind the curve. 00:02:45.410 --> 00:02:46.840 align:middle line:90% They should have started-- 00:02:46.840 --> 00:02:50.170 align:middle line:84% at least exposed, it's easy to see it that way. 00:02:50.170 --> 00:02:51.160 align:middle line:90% Remember what you have. 00:02:51.160 --> 00:02:52.780 align:middle line:84% If you have a situation where output 00:02:52.780 --> 00:02:55.030 align:middle line:84% is above potential output, the interest rate 00:02:55.030 --> 00:02:56.090 align:middle line:90% is supposed to be rising. 00:02:56.090 --> 00:02:58.720 align:middle line:84% So the Fed is supposed to be increasing the interest rate, 00:02:58.720 --> 00:03:00.160 align:middle line:90% but they didn't for a while. 00:03:00.160 --> 00:03:02.320 align:middle line:84% Assuming that the forces that were 00:03:02.320 --> 00:03:06.880 align:middle line:84% bringing potential output down and demand up were transitory. 00:03:06.880 --> 00:03:08.960 align:middle line:84% When they discovered that wasn't the case, 00:03:08.960 --> 00:03:10.720 align:middle line:90% they had to start catching up. 00:03:10.720 --> 00:03:13.580 align:middle line:84% As a result of that, they began to hike interest rates very, 00:03:13.580 --> 00:03:15.010 align:middle line:90% very rapidly. 00:03:15.010 --> 00:03:16.570 align:middle line:90% OK? 00:03:16.570 --> 00:03:20.740 align:middle line:84% Unusually rapidly for an economy like the US. 00:03:20.740 --> 00:03:24.170 align:middle line:84% There are many reasons why policymakers, 00:03:24.170 --> 00:03:25.780 align:middle line:84% especially monetary policy makers, 00:03:25.780 --> 00:03:29.890 align:middle line:84% prefer to be gradualist, meaning to move things in small steps 00:03:29.890 --> 00:03:35.160 align:middle line:84% rather than in one big bang, especially in the way up. 00:03:35.160 --> 00:03:37.750 align:middle line:84% It is to cut rates, they're very willing to be very 00:03:37.750 --> 00:03:39.100 align:middle line:90% aggressive in cutting rates. 00:03:39.100 --> 00:03:41.530 align:middle line:84% But raising rates is something they 00:03:41.530 --> 00:03:44.360 align:middle line:84% tend to be reluctant to do very, very rapidly. 00:03:44.360 --> 00:03:46.900 align:middle line:84% And one of the main reasons they are reluctant to do that 00:03:46.900 --> 00:03:48.850 align:middle line:84% very rapidly is because something 00:03:48.850 --> 00:03:50.957 align:middle line:84% may break in the process, and there 00:03:50.957 --> 00:03:53.290 align:middle line:84% are certain things that are very important if it breaks. 00:03:53.290 --> 00:03:54.430 align:middle line:84% There are certain other things that are not 00:03:54.430 --> 00:03:55.510 align:middle line:90% very important if they break. 00:03:55.510 --> 00:03:58.000 align:middle line:84% But one of the things that is very important if they break 00:03:58.000 --> 00:03:58.910 align:middle line:90% is banks. 00:03:58.910 --> 00:03:59.410 align:middle line:90% OK? 00:03:59.410 --> 00:04:02.410 align:middle line:84% And that's typically where you run into trouble 00:04:02.410 --> 00:04:06.220 align:middle line:84% when there is episodes of very fast hikes in rates. 00:04:06.220 --> 00:04:08.950 align:middle line:84% Now, because the US banking sector, especially 00:04:08.950 --> 00:04:12.380 align:middle line:84% the large banks, were very resilient, 00:04:12.380 --> 00:04:14.508 align:middle line:84% they had lots of capital and so on, there 00:04:14.508 --> 00:04:17.050 align:middle line:84% wasn't a lot of concern that that would be an issue in the US 00:04:17.050 --> 00:04:20.350 align:middle line:84% because, again, the big banks looked very healthy. 00:04:20.350 --> 00:04:22.089 align:middle line:84% Deposits were flowing out of big banks, 00:04:22.089 --> 00:04:24.880 align:middle line:84% but it was happening all at a normal pace. 00:04:24.880 --> 00:04:27.910 align:middle line:84% It's normal that deposits go out of the banking sector when 00:04:27.910 --> 00:04:29.740 align:middle line:90% interest rates start to rise. 00:04:29.740 --> 00:04:32.020 align:middle line:84% But there was no sign of any trouble. 00:04:32.020 --> 00:04:34.720 align:middle line:84% Well, that changed a month ago, as you well know, 00:04:34.720 --> 00:04:36.910 align:middle line:90% and something broke finally. 00:04:36.910 --> 00:04:41.260 align:middle line:84% The major episode there was the Silicon Valley Bank. 00:04:41.260 --> 00:04:45.790 align:middle line:84% We saw a big bank run there and eventually that bank collapsed. 00:04:45.790 --> 00:04:48.490 align:middle line:84% And since then, things have looked 00:04:48.490 --> 00:04:50.600 align:middle line:90% a little more complicated. 00:04:50.600 --> 00:04:55.960 align:middle line:84% So here you have, for example, commercial bank deposits. 00:04:55.960 --> 00:04:58.810 align:middle line:84% As I said, as the Fed began to hike-- 00:04:58.810 --> 00:05:00.430 align:middle line:90% so focus on the red line. 00:05:00.430 --> 00:05:04.990 align:middle line:84% The Fed began to hike rates, then deposits began to-- people 00:05:04.990 --> 00:05:07.990 align:middle line:84% began to move their money out of deposits into US 00:05:07.990 --> 00:05:11.120 align:middle line:84% treasuries, money market funds, things of that kind. 00:05:11.120 --> 00:05:12.540 align:middle line:90% But that was normal. 00:05:12.540 --> 00:05:13.040 align:middle line:90% OK? 00:05:13.040 --> 00:05:14.680 align:middle line:84% And that didn't lead to a big cut 00:05:14.680 --> 00:05:16.260 align:middle line:84% in lending, which is what you worry 00:05:16.260 --> 00:05:18.600 align:middle line:90% about when banks lose funding. 00:05:18.600 --> 00:05:21.300 align:middle line:84% But things began to change quite rapidly, well, 00:05:21.300 --> 00:05:23.070 align:middle line:90% in the second half of 2022. 00:05:23.070 --> 00:05:26.790 align:middle line:84% This was felt mostly by large banks. 00:05:26.790 --> 00:05:29.940 align:middle line:84% And when deposits decline gradually in large banks, 00:05:29.940 --> 00:05:33.120 align:middle line:84% that's not such a big issue because deposits are not 00:05:33.120 --> 00:05:35.790 align:middle line:84% the only funding source that big banks have. 00:05:35.790 --> 00:05:39.150 align:middle line:84% They have many other sources of funding. 00:05:39.150 --> 00:05:42.090 align:middle line:84% But then that's what happens this year. 00:05:42.090 --> 00:05:45.588 align:middle line:84% Things accelerated very, very quickly this year. 00:05:45.588 --> 00:05:46.630 align:middle line:90% And so this is different. 00:05:46.630 --> 00:05:48.390 align:middle line:84% This is a different animal from this sort 00:05:48.390 --> 00:05:50.370 align:middle line:84% of very controlled decline in deposits 00:05:50.370 --> 00:05:52.020 align:middle line:90% as interest rates were hiking. 00:05:52.020 --> 00:05:54.990 align:middle line:84% This is a very sharp decline in deposits. 00:05:54.990 --> 00:05:56.580 align:middle line:90% OK? 00:05:56.580 --> 00:06:02.620 align:middle line:84% So that's a problem because that unavoidably will hit lending. 00:06:02.620 --> 00:06:03.540 align:middle line:90% OK? 00:06:03.540 --> 00:06:07.170 align:middle line:84% So that's going to show up in terms of the models we have had. 00:06:07.170 --> 00:06:09.840 align:middle line:84% If you were to use your IS-LM-PC model, 00:06:09.840 --> 00:06:11.520 align:middle line:84% it would show up as an increase in x. 00:06:11.520 --> 00:06:14.035 align:middle line:84% Remember, we had risk premium and stuff like that. 00:06:14.035 --> 00:06:15.910 align:middle line:84% Well, that's the way you probably could model 00:06:15.910 --> 00:06:19.510 align:middle line:90% what is happening right now. 00:06:19.510 --> 00:06:20.970 align:middle line:90% Now, one of the-- 00:06:20.970 --> 00:06:24.430 align:middle line:84% as I said before, these are in different scales. 00:06:24.430 --> 00:06:28.140 align:middle line:84% So small bank deposits on the left, large bank 00:06:28.140 --> 00:06:30.150 align:middle line:90% deposits on the right. 00:06:30.150 --> 00:06:35.400 align:middle line:84% As I said before, through most of these episodes in which 00:06:35.400 --> 00:06:39.960 align:middle line:84% deposits were declining in the banking sector, 00:06:39.960 --> 00:06:44.910 align:middle line:84% it was mostly a phenomenon that affected large banks, 00:06:44.910 --> 00:06:46.810 align:middle line:90% and it was very gradual. 00:06:46.810 --> 00:06:47.550 align:middle line:90% OK. 00:06:47.550 --> 00:06:50.580 align:middle line:84% But what happened since a month ago is essentially small 00:06:50.580 --> 00:06:53.700 align:middle line:84% and medium sized banks experienced a very large run 00:06:53.700 --> 00:06:54.630 align:middle line:90% in deposits. 00:06:54.630 --> 00:06:57.960 align:middle line:84% Part of that went to money market US treasuries and part 00:06:57.960 --> 00:07:00.040 align:middle line:84% of it-- you don't see different scales and so on, 00:07:00.040 --> 00:07:01.590 align:middle line:84% but it went actually to large banks. 00:07:01.590 --> 00:07:02.700 align:middle line:90% It was relocation. 00:07:02.700 --> 00:07:04.410 align:middle line:90% That's called flight to quality. 00:07:04.410 --> 00:07:05.100 align:middle line:90% OK? 00:07:05.100 --> 00:07:12.030 align:middle line:84% Now even if this has been a full relocation of deposits 00:07:12.030 --> 00:07:13.740 align:middle line:90% from large banks-- 00:07:13.740 --> 00:07:16.380 align:middle line:84% from small banks to large banks, and so no 00:07:16.380 --> 00:07:19.030 align:middle line:84% deposit would have declined in the whole banking sector, that 00:07:19.030 --> 00:07:20.860 align:middle line:84% would have consequences for the economy 00:07:20.860 --> 00:07:22.600 align:middle line:84% because these type of banks don't lend 00:07:22.600 --> 00:07:25.030 align:middle line:90% to the same type of people. 00:07:25.030 --> 00:07:28.270 align:middle line:84% Small banks, small, especially regional banks, 00:07:28.270 --> 00:07:33.130 align:middle line:84% lend a lot to people that-- to businesses and people 00:07:33.130 --> 00:07:35.500 align:middle line:84% that do not have other sources of funding. 00:07:35.500 --> 00:07:37.850 align:middle line:84% They tend to be small businesses and so on. 00:07:37.850 --> 00:07:41.230 align:middle line:84% The only way they can borrow is either from the family 00:07:41.230 --> 00:07:42.320 align:middle line:90% or from a bank. 00:07:42.320 --> 00:07:45.040 align:middle line:84% But they cannot issue bonds and things like that, no? 00:07:45.040 --> 00:07:49.140 align:middle line:84% And so they don't have other sources of funding. 00:07:49.140 --> 00:07:52.490 align:middle line:84% And so that's a problem because what you see here is naturally 00:07:52.490 --> 00:07:56.720 align:middle line:84% when you start seeing deposits going out, there have been also 00:07:56.720 --> 00:07:59.150 align:middle line:84% losses experienced by the banks because they 00:07:59.150 --> 00:08:01.220 align:middle line:84% had to recognize the losses in the asset side 00:08:01.220 --> 00:08:04.310 align:middle line:84% once they lost deposit is that they had to cut lending. 00:08:04.310 --> 00:08:07.460 align:middle line:84% And you can see here what has been happening to lending. 00:08:07.460 --> 00:08:10.010 align:middle line:84% Large banks, they began to slow down here, 00:08:10.010 --> 00:08:11.510 align:middle line:90% but it's a gradual slow down. 00:08:11.510 --> 00:08:14.450 align:middle line:84% But you have seen a very sharp decline in lending 00:08:14.450 --> 00:08:16.590 align:middle line:84% over the last three or four weeks. 00:08:16.590 --> 00:08:17.090 align:middle line:90% OK? 00:08:17.090 --> 00:08:20.990 align:middle line:84% So we're in the early phases of what we like to call, 00:08:20.990 --> 00:08:23.550 align:middle line:90% as described as a credit crunch. 00:08:23.550 --> 00:08:24.050 align:middle line:90% OK? 00:08:24.050 --> 00:08:28.200 align:middle line:90% 00:08:28.200 --> 00:08:30.940 align:middle line:84% Now that's a problem, as I said before, 00:08:30.940 --> 00:08:36.539 align:middle line:84% because those banks, these banks, the banks in gray here, 00:08:36.539 --> 00:08:39.000 align:middle line:84% are the banks that lend primarily 00:08:39.000 --> 00:08:41.770 align:middle line:84% to small and medium sized businesses. 00:08:41.770 --> 00:08:46.140 align:middle line:84% So you see here the share of commercial and industrial loans 00:08:46.140 --> 00:08:48.330 align:middle line:90% by bank size. 00:08:48.330 --> 00:08:50.250 align:middle line:84% And this is loans to small businesses, 00:08:50.250 --> 00:08:51.630 align:middle line:90% loan to larger businesses. 00:08:51.630 --> 00:08:56.230 align:middle line:84% These are the banks that are in grave or below $250 billion, 00:08:56.230 --> 00:08:59.940 align:middle line:84% and you see that they have a large share of loans 00:08:59.940 --> 00:09:01.710 align:middle line:90% to small businesses. 00:09:01.710 --> 00:09:02.990 align:middle line:90% OK. 00:09:02.990 --> 00:09:05.400 align:middle line:84% So those sectors are going to suffer a lot. 00:09:05.400 --> 00:09:08.120 align:middle line:84% So there's going to be a contraction in the economy, 00:09:08.120 --> 00:09:10.100 align:middle line:84% and it's going to be very concentrated 00:09:10.100 --> 00:09:13.410 align:middle line:84% on small businesses, medium sized businesses, and so on. 00:09:13.410 --> 00:09:15.770 align:middle line:84% And again, it's more problematic, 00:09:15.770 --> 00:09:17.750 align:middle line:84% a contraction in lending to those businesses 00:09:17.750 --> 00:09:20.042 align:middle line:84% because they don't have alternative sources of funding. 00:09:20.042 --> 00:09:20.990 align:middle line:90% That's it. 00:09:20.990 --> 00:09:21.600 align:middle line:90% OK? 00:09:21.600 --> 00:09:26.900 align:middle line:84% It's either return earnings, the family is really, really small, 00:09:26.900 --> 00:09:29.990 align:middle line:90% or banks. 00:09:29.990 --> 00:09:32.840 align:middle line:90% 00:09:32.840 --> 00:09:34.490 align:middle line:84% Again, big corporations, these guys, 00:09:34.490 --> 00:09:37.250 align:middle line:84% probably are borrowing from 10 different banks 00:09:37.250 --> 00:09:40.460 align:middle line:84% and they have issued corporate bonds 00:09:40.460 --> 00:09:43.190 align:middle line:84% and they even have commercial paper. 00:09:43.190 --> 00:09:45.960 align:middle line:84% This is entirely different life when you live here 00:09:45.960 --> 00:09:49.145 align:middle line:90% and when you live here. 00:09:49.145 --> 00:09:50.520 align:middle line:84% If you look by sectors, that also 00:09:50.520 --> 00:09:52.920 align:middle line:84% is going to have implications for sectors. 00:09:52.920 --> 00:09:55.430 align:middle line:84% So this is going to be clearly contractionary, 00:09:55.430 --> 00:09:57.500 align:middle line:84% but it's not going to be equally contractionary. 00:09:57.500 --> 00:10:00.710 align:middle line:84% It will depend on the composition of your sectors. 00:10:00.710 --> 00:10:03.890 align:middle line:84% Not all sectors have the same share of small businesses 00:10:03.890 --> 00:10:06.170 align:middle line:90% and medium sized businesses. 00:10:06.170 --> 00:10:09.920 align:middle line:84% You see here the construction service has a very large share. 00:10:09.920 --> 00:10:12.380 align:middle line:84% More than half of the businesses in construction 00:10:12.380 --> 00:10:14.810 align:middle line:84% are really small or medium sized businesses. 00:10:14.810 --> 00:10:15.890 align:middle line:90% OK? 00:10:15.890 --> 00:10:18.890 align:middle line:84% Big contrast with utilities where they are 00:10:18.890 --> 00:10:21.110 align:middle line:90% all big businesses and so on. 00:10:21.110 --> 00:10:22.190 align:middle line:90% OK. 00:10:22.190 --> 00:10:24.530 align:middle line:84% So big dispersion, and so this is 00:10:24.530 --> 00:10:27.120 align:middle line:84% going to be a contraction that is going to be very felt-- 00:10:27.120 --> 00:10:30.890 align:middle line:84% is felt very strongly here at the top. 00:10:30.890 --> 00:10:32.900 align:middle line:84% So that's what is happening right now. 00:10:32.900 --> 00:10:35.420 align:middle line:84% And from the point of view of the aggregate, 00:10:35.420 --> 00:10:37.640 align:middle line:84% essentially where we have gone is from a path 00:10:37.640 --> 00:10:39.570 align:middle line:90% like this to a path like that. 00:10:39.570 --> 00:10:42.628 align:middle line:84% So the economy was overheating, so we needed 00:10:42.628 --> 00:10:43.670 align:middle line:90% to slow down the economy. 00:10:43.670 --> 00:10:45.320 align:middle line:90% There's no way around that. 00:10:45.320 --> 00:10:47.090 align:middle line:84% Output was above potential output. 00:10:47.090 --> 00:10:49.110 align:middle line:84% That was causing inflationary pressure. 00:10:49.110 --> 00:10:50.670 align:middle line:84% We needed to bring this stuff down, 00:10:50.670 --> 00:10:52.440 align:middle line:84% and the economy was slowing down. 00:10:52.440 --> 00:10:57.040 align:middle line:84% But it was happening at a very slow pace. 00:10:57.040 --> 00:11:00.300 align:middle line:84% And that was a bit exasperating for the Fed, 00:11:00.300 --> 00:11:02.520 align:middle line:84% but it was happening very, very slowly. 00:11:02.520 --> 00:11:04.230 align:middle line:84% Among other things, because the balance 00:11:04.230 --> 00:11:07.920 align:middle line:84% sheets of the household sector and corporations in general 00:11:07.920 --> 00:11:09.480 align:middle line:90% was very healthy. 00:11:09.480 --> 00:11:13.080 align:middle line:84% But now things are accelerating very quickly 00:11:13.080 --> 00:11:15.750 align:middle line:84% because once you introduce credit crunch, credit 00:11:15.750 --> 00:11:18.390 align:middle line:84% constraints, and things like that, 00:11:18.390 --> 00:11:22.050 align:middle line:84% the same declines in wealth that we were experiencing before that 00:11:22.050 --> 00:11:25.630 align:middle line:84% were driving aggregate demand down have a much larger effect. 00:11:25.630 --> 00:11:28.200 align:middle line:84% And so we're changing from a world that 00:11:28.200 --> 00:11:30.090 align:middle line:84% looked like that to a world that's going 00:11:30.090 --> 00:11:32.220 align:middle line:90% to look a lot more like this. 00:11:32.220 --> 00:11:34.170 align:middle line:84% And that's a tricky for the central bank 00:11:34.170 --> 00:11:36.720 align:middle line:90% because now the Fed needs to-- 00:11:36.720 --> 00:11:38.220 align:middle line:90% before there was no way around. 00:11:38.220 --> 00:11:42.300 align:middle line:84% They had to hike interest rate, because the main problem was 00:11:42.300 --> 00:11:43.290 align:middle line:90% inflation. 00:11:43.290 --> 00:11:46.020 align:middle line:84% Now they know that as they hike interest rate-- they still 00:11:46.020 --> 00:11:47.520 align:middle line:84% need to hike interest rate, I think, 00:11:47.520 --> 00:11:51.000 align:middle line:84% unless there is a big mess, because inflation is still 00:11:51.000 --> 00:11:53.010 align:middle line:90% way above their target. 00:11:53.010 --> 00:11:55.500 align:middle line:84% But they have to be very worried that this stuff doesn't 00:11:55.500 --> 00:11:57.690 align:middle line:90% become too steep. 00:11:57.690 --> 00:12:01.620 align:middle line:84% Things get to be very non-linear when the financial sector is 00:12:01.620 --> 00:12:03.312 align:middle line:90% involved. 00:12:03.312 --> 00:12:06.815 align:middle line:84% And so probably that means that on net, they already did it. 00:12:06.815 --> 00:12:08.190 align:middle line:84% In the previous meeting, everyone 00:12:08.190 --> 00:12:10.620 align:middle line:84% anticipated 50 basis points of hikes. 00:12:10.620 --> 00:12:15.690 align:middle line:84% Once SVB happened, the bets went down dramatically 00:12:15.690 --> 00:12:19.050 align:middle line:84% and the realization went down to 25 basis points. 00:12:19.050 --> 00:12:21.750 align:middle line:90% And so that's where we are now. 00:12:21.750 --> 00:12:24.780 align:middle line:84% Now if everything works as planned-- 00:12:24.780 --> 00:12:27.750 align:middle line:84% and more or less that's a forecast at this moment. 00:12:27.750 --> 00:12:29.640 align:middle line:90% There isn't any panic and so on. 00:12:29.640 --> 00:12:32.500 align:middle line:84% Is that we're going to experience not a technically 00:12:32.500 --> 00:12:37.300 align:middle line:84% a recession, but a significant slowdown in the next quarter 00:12:37.300 --> 00:12:37.900 align:middle line:90% or so. 00:12:37.900 --> 00:12:40.462 align:middle line:90% OK? 00:12:40.462 --> 00:12:43.090 align:middle line:84% That's sort of the consensus expecting 00:12:43.090 --> 00:12:47.530 align:middle line:84% to see as a result of all these combined forces. 00:12:47.530 --> 00:12:49.210 align:middle line:84% A Fed that still needs to tighten 00:12:49.210 --> 00:12:52.840 align:middle line:84% because of aggregate demand reasons and the very negative 00:12:52.840 --> 00:12:54.970 align:middle line:84% effect of the credit crunch, especially 00:12:54.970 --> 00:12:57.230 align:middle line:90% in certain parts of the economy. 00:12:57.230 --> 00:12:58.390 align:middle line:90% OK? 00:12:58.390 --> 00:13:01.750 align:middle line:84% If everything, again, works as planned means things continue 00:13:01.750 --> 00:13:06.850 align:middle line:84% to go fairly smoothly, then it's certainly not 00:13:06.850 --> 00:13:10.490 align:middle line:84% going to be a good year for economic activity 00:13:10.490 --> 00:13:12.700 align:middle line:84% but it shouldn't be a disaster either. 00:13:12.700 --> 00:13:14.290 align:middle line:90% That's sort of where we are at. 00:13:14.290 --> 00:13:19.480 align:middle line:84% And the tension is, well, if the financial crisis 00:13:19.480 --> 00:13:23.830 align:middle line:84% leaks into the larger banks, then these numbers 00:13:23.830 --> 00:13:26.020 align:middle line:84% are going to get a lot worse, of course. 00:13:26.020 --> 00:13:29.740 align:middle line:84% But that's the concern at the moment. 00:13:29.740 --> 00:13:33.440 align:middle line:84% But it doesn't seem like the central scenario. 00:13:33.440 --> 00:13:35.720 align:middle line:84% Now, there are also some good news 00:13:35.720 --> 00:13:38.300 align:middle line:84% happening because remember that the problem we had-- 00:13:38.300 --> 00:13:40.200 align:middle line:84% the problem we have comes from two sides. 00:13:40.200 --> 00:13:43.820 align:middle line:84% One side is too much demand, and that the Fed 00:13:43.820 --> 00:13:45.330 align:middle line:90% can affect very quickly. 00:13:45.330 --> 00:13:48.170 align:middle line:84% That's what it's doing by hiking interest rates. 00:13:48.170 --> 00:13:50.180 align:middle line:84% Not as quickly as they would like, 00:13:50.180 --> 00:13:53.430 align:middle line:84% but still, they have an impact on that. 00:13:53.430 --> 00:13:55.640 align:middle line:84% But the other problem was aggregate supply. 00:13:55.640 --> 00:13:59.425 align:middle line:84% And in particular, it's that the labor market looked very tight. 00:13:59.425 --> 00:14:01.550 align:middle line:84% And remember when we did the Phillips curve and all 00:14:01.550 --> 00:14:04.370 align:middle line:84% that, the labor market is very critical in all 00:14:04.370 --> 00:14:07.140 align:middle line:84% the process of generating inflation and so on. 00:14:07.140 --> 00:14:11.210 align:middle line:84% That's the reason you try to generate more unemployment, 00:14:11.210 --> 00:14:14.240 align:middle line:84% essentially to lower wage pressure, because that 00:14:14.240 --> 00:14:17.850 align:middle line:84% means less pressure on prices and so on and so forth. 00:14:17.850 --> 00:14:20.960 align:middle line:84% And one of the problems is that, again, 00:14:20.960 --> 00:14:23.990 align:middle line:84% is very nice in principle, that we have very low unemployment 00:14:23.990 --> 00:14:24.500 align:middle line:90% rate. 00:14:24.500 --> 00:14:27.530 align:middle line:84% But it's very difficult to lower wage pressure 00:14:27.530 --> 00:14:31.160 align:middle line:90% if unemployment is so low. 00:14:31.160 --> 00:14:33.480 align:middle line:84% Having said this-- and this is the part that I say 00:14:33.480 --> 00:14:35.400 align:middle line:90% is fairly good news. 00:14:35.400 --> 00:14:38.220 align:middle line:84% Having said this, in the model we simplify things 00:14:38.220 --> 00:14:40.890 align:middle line:84% and we just put unemployment as the only variable 00:14:40.890 --> 00:14:43.170 align:middle line:84% that could adjust and that was important for wages 00:14:43.170 --> 00:14:44.670 align:middle line:90% aside from some institutional. 00:14:44.670 --> 00:14:47.460 align:middle line:84% Things in practice, there are many other indicators. 00:14:47.460 --> 00:14:49.980 align:middle line:84% And really what really matters is employment. 00:14:49.980 --> 00:14:52.290 align:middle line:84% What happens is we took a fixed n, 00:14:52.290 --> 00:14:54.245 align:middle line:84% we took a fixed the participation rate, 00:14:54.245 --> 00:14:56.370 align:middle line:84% and that's the reason unemployment was the variable 00:14:56.370 --> 00:14:57.450 align:middle line:90% to summarize everything. 00:14:57.450 --> 00:15:00.180 align:middle line:84% But what really puts pressure on labor market 00:15:00.180 --> 00:15:02.518 align:middle line:90% is shortage of workers. 00:15:02.518 --> 00:15:04.560 align:middle line:84% If you have an unemployment rate that is constant 00:15:04.560 --> 00:15:08.520 align:middle line:84% but there are lots of workers coming into the labor force, 00:15:08.520 --> 00:15:11.550 align:middle line:84% then that doesn't put as much pressure on wages, 00:15:11.550 --> 00:15:13.650 align:middle line:84% and therefore less pressure on inflation. 00:15:13.650 --> 00:15:15.570 align:middle line:84% And this is exactly what we're beginning 00:15:15.570 --> 00:15:18.330 align:middle line:84% to see in the US economy, and I think that's very good news. 00:15:18.330 --> 00:15:21.360 align:middle line:84% It gives us hope that this inflationary process may 00:15:21.360 --> 00:15:24.440 align:middle line:90% come down a little faster. 00:15:24.440 --> 00:15:26.900 align:middle line:84% So this is labor market participation. 00:15:26.900 --> 00:15:27.400 align:middle line:90% Remember? 00:15:27.400 --> 00:15:31.000 align:middle line:84% So this unemployment number spiked a lot, 00:15:31.000 --> 00:15:34.120 align:middle line:84% but it underrepresented how much contraction there 00:15:34.120 --> 00:15:36.550 align:middle line:84% was in labor, in employment, and so on, 00:15:36.550 --> 00:15:40.240 align:middle line:84% because many people simply exit the labor force and those, 00:15:40.240 --> 00:15:43.030 align:middle line:84% remember, we don't count as unemployed OK? 00:15:43.030 --> 00:15:44.740 align:middle line:90% And so that happened. 00:15:44.740 --> 00:15:47.710 align:middle line:84% It was a very sharp decline in the labor force, 00:15:47.710 --> 00:15:50.560 align:middle line:84% in the labor participation rate, so the decline 00:15:50.560 --> 00:15:51.700 align:middle line:90% in the labor force. 00:15:51.700 --> 00:15:53.800 align:middle line:84% And then that recovery is one of the things 00:15:53.800 --> 00:15:56.350 align:middle line:84% that happened much slower than the Fed anticipated. 00:15:56.350 --> 00:15:59.680 align:middle line:84% That was part of the mistake is they thought that this was going 00:15:59.680 --> 00:16:03.160 align:middle line:84% to come back quickly and that for potential output was going 00:16:03.160 --> 00:16:05.200 align:middle line:84% to rise very quickly, and it didn't. 00:16:05.200 --> 00:16:08.690 align:middle line:84% That was one of the mistakes, the forecast mistakes. 00:16:08.690 --> 00:16:10.450 align:middle line:84% But now it's clearly that it's coming back 00:16:10.450 --> 00:16:12.580 align:middle line:84% to levels that are more consistent 00:16:12.580 --> 00:16:16.040 align:middle line:90% with historical levels. 00:16:16.040 --> 00:16:18.580 align:middle line:84% If you look at the employment to population ratio, 00:16:18.580 --> 00:16:21.320 align:middle line:84% also a big decline for similar reasons. 00:16:21.320 --> 00:16:24.100 align:middle line:84% But if you look at employment to population ratio today, 00:16:24.100 --> 00:16:28.130 align:middle line:84% it's clearly getting back to the trend it had before. 00:16:28.130 --> 00:16:28.630 align:middle line:90% OK. 00:16:28.630 --> 00:16:31.420 align:middle line:84% So that's very good news in the sense 00:16:31.420 --> 00:16:33.730 align:middle line:84% that even if unemployment doesn't move a lot, 00:16:33.730 --> 00:16:35.515 align:middle line:90% this reduces-- 00:16:35.515 --> 00:16:36.640 align:middle line:90% well, it's good for output. 00:16:36.640 --> 00:16:38.060 align:middle line:90% It expands and so on. 00:16:38.060 --> 00:16:42.220 align:middle line:84% But it also lowers inflationary pressures in the economy. 00:16:42.220 --> 00:16:45.610 align:middle line:84% And another component actually that I 00:16:45.610 --> 00:16:48.670 align:middle line:84% think I mentioned a couple of times in the lecture 00:16:48.670 --> 00:16:50.050 align:middle line:90% is immigration. 00:16:50.050 --> 00:16:53.350 align:middle line:84% In a market like the US, a lot of the labor forces 00:16:53.350 --> 00:16:54.880 align:middle line:90% comes from immigration. 00:16:54.880 --> 00:16:55.420 align:middle line:90% OK? 00:16:55.420 --> 00:16:58.300 align:middle line:84% And that stopped for a while for a variety of reasons, 00:16:58.300 --> 00:17:01.690 align:middle line:84% but certainly COVID had a big effect. 00:17:01.690 --> 00:17:08.200 align:middle line:84% So that meant about 500,000 less people a year coming into the US 00:17:08.200 --> 00:17:10.310 align:middle line:84% labor force, and that has big impacts, 00:17:10.310 --> 00:17:12.680 align:middle line:84% especially in some sectors of the economy. 00:17:12.680 --> 00:17:13.630 align:middle line:90% OK? 00:17:13.630 --> 00:17:16.819 align:middle line:84% And that's clearly been fixed now. 00:17:16.819 --> 00:17:17.645 align:middle line:90% OK? 00:17:17.645 --> 00:17:18.770 align:middle line:90% We may have other problems. 00:17:18.770 --> 00:17:21.109 align:middle line:84% People may fight for political reasons and these things 00:17:21.109 --> 00:17:23.869 align:middle line:84% and whatever, but from the point of view of macro, 00:17:23.869 --> 00:17:26.240 align:middle line:90% this is certainly helping. 00:17:26.240 --> 00:17:27.619 align:middle line:90% OK? 00:17:27.619 --> 00:17:31.040 align:middle line:84% In fact, if you look at where the wage pressure is really 00:17:31.040 --> 00:17:33.830 align:middle line:84% coming from in the US economy, it's coming from those sectors 00:17:33.830 --> 00:17:37.940 align:middle line:84% where immigrants play a big role. 00:17:37.940 --> 00:17:40.700 align:middle line:84% Accommodation, food services, stuff like that, 00:17:40.700 --> 00:17:43.970 align:middle line:84% you see that their sort of wages rose pretty dramatically 00:17:43.970 --> 00:17:46.590 align:middle line:84% because there was a massive shortage there for two reasons. 00:17:46.590 --> 00:17:50.390 align:middle line:84% One, people didn't want to go back to those sectors to work, 00:17:50.390 --> 00:17:52.430 align:middle line:84% close contact and stuff like that. 00:17:52.430 --> 00:17:56.360 align:middle line:84% And the other one is that the important flow 00:17:56.360 --> 00:17:59.630 align:middle line:84% of supply of workers into that had slowed down 00:17:59.630 --> 00:18:00.620 align:middle line:90% quite dramatically. 00:18:00.620 --> 00:18:01.280 align:middle line:90% OK? 00:18:01.280 --> 00:18:03.410 align:middle line:90% So that's where we're at. 00:18:03.410 --> 00:18:05.780 align:middle line:84% And as a result of all these good forces, 00:18:05.780 --> 00:18:09.665 align:middle line:84% despite the fact that we have very low unemployment, 00:18:09.665 --> 00:18:11.900 align:middle line:84% you can see that wage pressure is 00:18:11.900 --> 00:18:13.410 align:middle line:90% beginning to decline in the US. 00:18:13.410 --> 00:18:13.910 align:middle line:90% OK? 00:18:13.910 --> 00:18:16.610 align:middle line:84% So it was very high there, but those numbers 00:18:16.610 --> 00:18:19.130 align:middle line:84% are very distorted by composition effects and stuff 00:18:19.130 --> 00:18:19.783 align:middle line:90% like that. 00:18:19.783 --> 00:18:21.950 align:middle line:84% But these were the numbers that were very worrisome. 00:18:21.950 --> 00:18:23.930 align:middle line:84% I mean, with wage inflation of 6%, 00:18:23.930 --> 00:18:27.680 align:middle line:84% it's going to be very difficult to bring inflation to 2% down. 00:18:27.680 --> 00:18:29.670 align:middle line:84% You need much lower wage inflation. 00:18:29.670 --> 00:18:32.750 align:middle line:84% But you see that is beginning to decline. 00:18:32.750 --> 00:18:35.960 align:middle line:84% 2% is still too high for a steady state 00:18:35.960 --> 00:18:38.393 align:middle line:84% if you want to go back to 2% inflation rate 00:18:38.393 --> 00:18:40.310 align:middle line:84% because you can have an increase in real wage, 00:18:40.310 --> 00:18:42.935 align:middle line:84% but that has to be more or less aligned with the rate of growth 00:18:42.935 --> 00:18:44.160 align:middle line:90% of productivity. 00:18:44.160 --> 00:18:45.770 align:middle line:90% Which is much lower than that. 00:18:45.770 --> 00:18:48.860 align:middle line:84% I mean, at best it's 1%, 1 and 1/2 sometimes. 00:18:48.860 --> 00:18:55.700 align:middle line:84% So you could live with 3.5% real nominal wage growth, but 4, 00:18:55.700 --> 00:18:59.810 align:middle line:90% 4 and 1/2 is a bit too much. 00:18:59.810 --> 00:19:00.350 align:middle line:90% OK. 00:19:00.350 --> 00:19:03.605 align:middle line:84% Anyway, so that's the state of the economy. 00:19:03.605 --> 00:19:05.480 align:middle line:84% Any questions about the state of the economy? 00:19:05.480 --> 00:19:07.428 align:middle line:90% Open question. 00:19:07.428 --> 00:19:08.770 align:middle line:90% No? 00:19:08.770 --> 00:19:09.270 align:middle line:90% No? 00:19:09.270 --> 00:19:11.020 align:middle line:90% You're happy with it? 00:19:11.020 --> 00:19:11.920 align:middle line:90% Doing fine? 00:19:11.920 --> 00:19:12.790 align:middle line:90% OK. 00:19:12.790 --> 00:19:13.630 align:middle line:90% Good. 00:19:13.630 --> 00:19:18.880 align:middle line:84% So what I want to do next is so this was a summary and all 00:19:18.880 --> 00:19:21.970 align:middle line:84% that I did here I did close economy economics. 00:19:21.970 --> 00:19:23.918 align:middle line:84% All my description, I didn't need 00:19:23.918 --> 00:19:26.210 align:middle line:84% to tell you what was happening in the rest of the world 00:19:26.210 --> 00:19:26.920 align:middle line:90% and so on. 00:19:26.920 --> 00:19:28.660 align:middle line:84% That would have been a lot harder 00:19:28.660 --> 00:19:32.147 align:middle line:84% to do if this was Singapore, for example, because Singapore 00:19:32.147 --> 00:19:33.730 align:middle line:84% depends a lot on the rest of the world 00:19:33.730 --> 00:19:35.020 align:middle line:84% and it's very difficult to tell a story 00:19:35.020 --> 00:19:37.210 align:middle line:84% that just depends on what happens in Singapore. 00:19:37.210 --> 00:19:41.320 align:middle line:84% The US is pretty unique in that you can tell most of the story 00:19:41.320 --> 00:19:43.040 align:middle line:90% based on what happens in the US. 00:19:43.040 --> 00:19:43.540 align:middle line:90% Most. 00:19:43.540 --> 00:19:45.260 align:middle line:90% Not all, but most of the story. 00:19:45.260 --> 00:19:47.140 align:middle line:90% And that's what I just did. 00:19:47.140 --> 00:19:50.410 align:middle line:84% Almost anywhere else, you need to think about-- 00:19:50.410 --> 00:19:51.520 align:middle line:90% even if you're in Japan. 00:19:51.520 --> 00:19:52.840 align:middle line:90% Big economy and so on. 00:19:52.840 --> 00:19:54.057 align:middle line:90% Effects will play a big role. 00:19:54.057 --> 00:19:56.140 align:middle line:84% And so when you describe the state of the economy, 00:19:56.140 --> 00:19:58.360 align:middle line:84% you're going to be talking about the yen. 00:19:58.360 --> 00:20:01.600 align:middle line:90% Very high, very low, or not. 00:20:01.600 --> 00:20:04.120 align:middle line:84% Here you don't worry much about the dollar. 00:20:04.120 --> 00:20:07.150 align:middle line:90% The US is very unique on that. 00:20:07.150 --> 00:20:10.490 align:middle line:84% I think no other country in the world has that feature. 00:20:10.490 --> 00:20:10.990 align:middle line:90% OK? 00:20:10.990 --> 00:20:13.600 align:middle line:84% So now we're going to open up the economy, 00:20:13.600 --> 00:20:17.230 align:middle line:84% and again, perhaps it's the least important for the US 00:20:17.230 --> 00:20:19.930 align:middle line:84% but anywhere else it's tremendously important. 00:20:19.930 --> 00:20:22.420 align:middle line:84% More so it's becoming increasingly 00:20:22.420 --> 00:20:24.165 align:middle line:90% important for the US. 00:20:24.165 --> 00:20:25.540 align:middle line:84% It has been becoming increasingly 00:20:25.540 --> 00:20:26.470 align:middle line:90% important in the US. 00:20:26.470 --> 00:20:29.080 align:middle line:84% Now we're in the middle of a deglobalization mess. 00:20:29.080 --> 00:20:31.180 align:middle line:90% We shall see where we end up. 00:20:31.180 --> 00:20:34.660 align:middle line:84% So there has been a bit of a reversion of a very strong trend 00:20:34.660 --> 00:20:37.330 align:middle line:84% towards integrating the economies of the world 00:20:37.330 --> 00:20:39.230 align:middle line:90% through many different channels. 00:20:39.230 --> 00:20:43.238 align:middle line:84% And so I want to talk about what are the key variables when 00:20:43.238 --> 00:20:45.280 align:middle line:84% you integrate an economy to the rest of the world 00:20:45.280 --> 00:20:48.160 align:middle line:90% and things of that kind. 00:20:48.160 --> 00:20:50.450 align:middle line:84% I'm going to start with some definitions. 00:20:50.450 --> 00:20:52.030 align:middle line:84% What are variables that we're going 00:20:52.030 --> 00:20:55.635 align:middle line:84% to be talking about that we weren't talking about up to now? 00:20:55.635 --> 00:20:57.010 align:middle line:84% So one of the things that's going 00:20:57.010 --> 00:21:00.280 align:middle line:84% to be very important in an open economy is the exchange rate. 00:21:00.280 --> 00:21:00.858 align:middle line:90% OK? 00:21:00.858 --> 00:21:01.900 align:middle line:90% And here I'm giving you-- 00:21:01.900 --> 00:21:04.630 align:middle line:84% I'm going to define things very formally later on, 00:21:04.630 --> 00:21:09.190 align:middle line:84% but here you see an example of the US dollar 00:21:09.190 --> 00:21:12.020 align:middle line:84% vis a vis the main trading partners. 00:21:12.020 --> 00:21:14.750 align:middle line:84% The US trades with many different parts of the world, 00:21:14.750 --> 00:21:17.960 align:middle line:84% and there's bilateral effects between those things. 00:21:17.960 --> 00:21:19.760 align:middle line:84% And this measure here is something 00:21:19.760 --> 00:21:21.620 align:middle line:84% that weights by the amount of trade 00:21:21.620 --> 00:21:23.810 align:middle line:84% that we have with different economies of the world, 00:21:23.810 --> 00:21:25.650 align:middle line:84% trades the different effects and says, well, 00:21:25.650 --> 00:21:29.058 align:middle line:84% is the dollar strong, weak, or whatever. 00:21:29.058 --> 00:21:30.350 align:middle line:90% This is a matter of convention. 00:21:30.350 --> 00:21:32.690 align:middle line:90% There's many ways you can-- 00:21:32.690 --> 00:21:34.670 align:middle line:84% no, there are two ways in which you can do it, 00:21:34.670 --> 00:21:36.570 align:middle line:84% but we're going to do it the following way. 00:21:36.570 --> 00:21:39.440 align:middle line:84% What these effects will reflect is 00:21:39.440 --> 00:21:42.750 align:middle line:84% the price of the domestic currency in foreign currency 00:21:42.750 --> 00:21:43.250 align:middle line:90% terms. 00:21:43.250 --> 00:21:47.150 align:middle line:84% So that means when this goes up, means the dollar 00:21:47.150 --> 00:21:49.780 align:middle line:90% was becoming very expensive. 00:21:49.780 --> 00:21:50.280 align:middle line:90% OK? 00:21:50.280 --> 00:21:52.740 align:middle line:90% And that's a very sharp-- 00:21:52.740 --> 00:21:55.380 align:middle line:84% I'll get back to it, but we call that an appreciation 00:21:55.380 --> 00:21:56.350 align:middle line:90% of the currency. 00:21:56.350 --> 00:21:56.850 align:middle line:90% OK? 00:21:56.850 --> 00:22:01.080 align:middle line:84% So here the dollar was becoming very expensive in terms 00:22:01.080 --> 00:22:03.990 align:middle line:90% of other currencies. 00:22:03.990 --> 00:22:08.130 align:middle line:84% The opposite happens starting the second half of 2022. 00:22:08.130 --> 00:22:12.823 align:middle line:84% Now we have had some cycles here during this year. 00:22:12.823 --> 00:22:15.240 align:middle line:84% That's going to be a very important variable, the effects. 00:22:15.240 --> 00:22:16.990 align:middle line:84% We call it the effects, the exchange rate. 00:22:16.990 --> 00:22:19.960 align:middle line:90% 00:22:19.960 --> 00:22:22.360 align:middle line:84% Another variable that we haven't talked about 00:22:22.360 --> 00:22:26.080 align:middle line:84% but that is going to be important here is-- 00:22:26.080 --> 00:22:30.910 align:middle line:84% and that politicians argue a lot about it 00:22:30.910 --> 00:22:34.270 align:middle line:84% with the wrong arguments, but they do, 00:22:34.270 --> 00:22:38.590 align:middle line:84% is the trade balance of goods and services. 00:22:38.590 --> 00:22:40.160 align:middle line:90% Of goods and services. 00:22:40.160 --> 00:22:42.760 align:middle line:84% So this, the trade balance of goods and services, 00:22:42.760 --> 00:22:48.680 align:middle line:84% is simply the difference between the exports, 00:22:48.680 --> 00:22:51.250 align:middle line:84% so what a country sells to the rest of the world, 00:22:51.250 --> 00:22:52.780 align:middle line:90% versus its import. 00:22:52.780 --> 00:22:55.630 align:middle line:84% That is how much it buys from the rest of the world. 00:22:55.630 --> 00:22:56.260 align:middle line:90% OK? 00:22:56.260 --> 00:22:59.050 align:middle line:84% So this is monthly data for the US. 00:22:59.050 --> 00:23:03.440 align:middle line:84% The US nowadays of runs a deficit, 00:23:03.440 --> 00:23:09.570 align:middle line:84% a trade balance deficit of the order of $70 billion a month. 00:23:09.570 --> 00:23:14.900 align:middle line:84% That means exports to the rest of the world about $70 billion 00:23:14.900 --> 00:23:16.890 align:middle line:90% less than it imports. 00:23:16.890 --> 00:23:17.390 align:middle line:90% Sorry. 00:23:17.390 --> 00:23:17.840 align:middle line:90% Sorry. 00:23:17.840 --> 00:23:18.340 align:middle line:90% Yeah. 00:23:18.340 --> 00:23:19.970 align:middle line:90% 70 less than it imports. 00:23:19.970 --> 00:23:20.840 align:middle line:90% Perfect. 00:23:20.840 --> 00:23:21.980 align:middle line:90% OK. 00:23:21.980 --> 00:23:28.100 align:middle line:84% You have seen that this is pretty sustained, actually. 00:23:28.100 --> 00:23:33.380 align:middle line:84% Here it looks pretty balanced, but the US, on average, 00:23:33.380 --> 00:23:35.400 align:middle line:90% has a situation like that. 00:23:35.400 --> 00:23:35.900 align:middle line:90% OK? 00:23:35.900 --> 00:23:39.140 align:middle line:84% The US tends to export less than it imports, 00:23:39.140 --> 00:23:42.080 align:middle line:84% and then that's when politicians get all very worked out. 00:23:42.080 --> 00:23:44.420 align:middle line:84% They say, this is unfair competition 00:23:44.420 --> 00:23:46.790 align:middle line:84% from the rest of the world and so on and so forth. 00:23:46.790 --> 00:23:49.490 align:middle line:84% I think in general, it has very little to do with that. 00:23:49.490 --> 00:23:53.120 align:middle line:84% It has to do with the fact that the US likes 00:23:53.120 --> 00:23:56.750 align:middle line:84% to save less than the rest of the world. 00:23:56.750 --> 00:24:00.030 align:middle line:84% But let me not get into that until much later in the course. 00:24:00.030 --> 00:24:04.390 align:middle line:84% But anyway, that's the situation for the US. 00:24:04.390 --> 00:24:07.160 align:middle line:84% This is obviously a blip that has to do with COVID and so on, 00:24:07.160 --> 00:24:09.220 align:middle line:84% but you see that we're now more or less 00:24:09.220 --> 00:24:12.790 align:middle line:90% back to where we were before. 00:24:12.790 --> 00:24:15.190 align:middle line:84% This was a period, actually, of lots 00:24:15.190 --> 00:24:19.120 align:middle line:84% of global political tensions because it had one counterpart 00:24:19.120 --> 00:24:20.060 align:middle line:90% that was very big. 00:24:20.060 --> 00:24:21.810 align:middle line:90% It was China. 00:24:21.810 --> 00:24:23.620 align:middle line:90% OK? 00:24:23.620 --> 00:24:27.690 align:middle line:84% The time of the global imbalances in the US 00:24:27.690 --> 00:24:30.210 align:middle line:84% was learning very large trade deficit, 00:24:30.210 --> 00:24:33.570 align:middle line:84% and then China in particular was running very large trade 00:24:33.570 --> 00:24:36.540 align:middle line:84% surpluses, and so there were lots of political quarrels 00:24:36.540 --> 00:24:37.230 align:middle line:90% because of that. 00:24:37.230 --> 00:24:41.140 align:middle line:90% 00:24:41.140 --> 00:24:44.290 align:middle line:84% So obviously the US has many, many trading partners, 00:24:44.290 --> 00:24:46.000 align:middle line:84% and with respect to many of them, 00:24:46.000 --> 00:24:48.170 align:middle line:90% it has very large deficits. 00:24:48.170 --> 00:24:49.030 align:middle line:90% So on net. 00:24:49.030 --> 00:24:50.950 align:middle line:90% And here are the main-- 00:24:50.950 --> 00:24:55.300 align:middle line:84% I ranked the 10 main deficits for the US. 00:24:55.300 --> 00:24:57.910 align:middle line:90% So I don't know when was this. 00:24:57.910 --> 00:25:04.980 align:middle line:84% But anyways, it looks like that for the last eight or so years. 00:25:04.980 --> 00:25:08.400 align:middle line:84% Remove COVID, it looks more or less like this all the time. 00:25:08.400 --> 00:25:13.890 align:middle line:84% And you see that the US, indeed, large exports to China, 00:25:13.890 --> 00:25:19.760 align:middle line:84% about $153 billion a year, and it imports about $536 billion 00:25:19.760 --> 00:25:20.260 align:middle line:90% a year. 00:25:20.260 --> 00:25:25.350 align:middle line:84% So the net deficit is $380 billion a year. 00:25:25.350 --> 00:25:27.360 align:middle line:84% That's the reason this is a big political thing. 00:25:27.360 --> 00:25:27.960 align:middle line:90% OK? 00:25:27.960 --> 00:25:29.980 align:middle line:90% It sounds like a big deficit. 00:25:29.980 --> 00:25:31.230 align:middle line:90% But there are other countries. 00:25:31.230 --> 00:25:34.560 align:middle line:84% With respect to Mexico, $130 billion, and so on. 00:25:34.560 --> 00:25:38.190 align:middle line:84% The US exports a lot more to Mexico. 00:25:38.190 --> 00:25:39.120 align:middle line:90% Vietnam. 00:25:39.120 --> 00:25:40.560 align:middle line:84% A lot of what happens from Vietnam 00:25:40.560 --> 00:25:44.460 align:middle line:84% is really Chinese exports in disguise. 00:25:44.460 --> 00:25:45.810 align:middle line:90% But there you see it. 00:25:45.810 --> 00:25:46.320 align:middle line:90% OK? 00:25:46.320 --> 00:25:47.430 align:middle line:90% There are many others. 00:25:47.430 --> 00:25:50.730 align:middle line:84% Germany is always a problem, but-- 00:25:50.730 --> 00:25:57.640 align:middle line:84% a problem for somebody that sees deficits as a problem and so on. 00:25:57.640 --> 00:25:58.140 align:middle line:90% OK. 00:25:58.140 --> 00:26:01.740 align:middle line:90% 00:26:01.740 --> 00:26:05.400 align:middle line:90% Now that's on the good side. 00:26:05.400 --> 00:26:09.270 align:middle line:84% What I was saying here is that one sense of openness 00:26:09.270 --> 00:26:11.560 align:middle line:84% is in the goods and services market. 00:26:11.560 --> 00:26:13.590 align:middle line:84% So you buy goods from the rest of the world, 00:26:13.590 --> 00:26:15.930 align:middle line:84% the rest of the world buys goods from you. 00:26:15.930 --> 00:26:17.460 align:middle line:84% Sometimes these things are balanced, 00:26:17.460 --> 00:26:20.505 align:middle line:90% sometimes they are not. 00:26:20.505 --> 00:26:21.900 align:middle line:84% When at the aggregate level, they 00:26:21.900 --> 00:26:23.900 align:middle line:84% are not balanced for a very long period of time, 00:26:23.900 --> 00:26:28.500 align:middle line:84% unless you're the US, that often causes problems. 00:26:28.500 --> 00:26:31.950 align:middle line:84% But at the bilateral level, if you look at any country, 00:26:31.950 --> 00:26:34.140 align:middle line:90% we'll have situations like this. 00:26:34.140 --> 00:26:36.630 align:middle line:84% Some countries where they export a lot to and import very 00:26:36.630 --> 00:26:38.920 align:middle line:90% little from and vice versa. 00:26:38.920 --> 00:26:40.770 align:middle line:90% But that's the way the US looks. 00:26:40.770 --> 00:26:43.710 align:middle line:84% Another sense of openness, which is very important 00:26:43.710 --> 00:26:47.340 align:middle line:90% is financial openness. 00:26:47.340 --> 00:26:50.580 align:middle line:84% Meaning that you can also buy or save 00:26:50.580 --> 00:26:54.570 align:middle line:84% using foreign assets or domestic assets. 00:26:54.570 --> 00:26:58.170 align:middle line:84% So you can buy foreign assets-- perhaps not 00:26:58.170 --> 00:27:00.390 align:middle line:84% you directly or most of you directly, 00:27:00.390 --> 00:27:02.640 align:middle line:84% but you can do it through a broker and so on. 00:27:02.640 --> 00:27:05.730 align:middle line:84% You can buy foreign assets, and foreigners 00:27:05.730 --> 00:27:08.390 align:middle line:90% buy lots of US assets. 00:27:08.390 --> 00:27:08.890 align:middle line:90% OK? 00:27:08.890 --> 00:27:11.590 align:middle line:84% That's a sense of openness in financial markets, 00:27:11.590 --> 00:27:12.580 align:middle line:90% that you can buy-- 00:27:12.580 --> 00:27:16.240 align:middle line:84% you're not stuck with your country's financial assets. 00:27:16.240 --> 00:27:19.240 align:middle line:84% You can also invest in other countries' financial assets 00:27:19.240 --> 00:27:21.620 align:middle line:90% and vice versa. 00:27:21.620 --> 00:27:23.960 align:middle line:90% Those things probably you as-- 00:27:23.960 --> 00:27:26.540 align:middle line:84% I mean, you know this trade openness a lot 00:27:26.540 --> 00:27:29.362 align:middle line:84% more probably than financial openness 00:27:29.362 --> 00:27:31.820 align:middle line:84% because you're all the time buying imported goods and stuff 00:27:31.820 --> 00:27:36.025 align:middle line:84% like that, while you're probably not 00:27:36.025 --> 00:27:37.400 align:middle line:84% involved in a lot of transactions 00:27:37.400 --> 00:27:40.170 align:middle line:84% of international financial instruments and so on. 00:27:40.170 --> 00:27:42.230 align:middle line:90% But they are very large. 00:27:42.230 --> 00:27:43.340 align:middle line:90% OK? 00:27:43.340 --> 00:27:45.800 align:middle line:84% So pension funds and so on, they're 00:27:45.800 --> 00:27:48.090 align:middle line:84% all involved in very large transactions. 00:27:48.090 --> 00:27:50.180 align:middle line:84% In fact, transactions in financial markets 00:27:50.180 --> 00:27:52.580 align:middle line:84% are an order of magnitude larger than transactions 00:27:52.580 --> 00:27:53.900 align:middle line:90% in the goods market. 00:27:53.900 --> 00:27:54.840 align:middle line:90% Very large. 00:27:54.840 --> 00:28:02.750 align:middle line:84% And here you have an example by origin, the foreign holdings 00:28:02.750 --> 00:28:04.730 align:middle line:90% of US assets. 00:28:04.730 --> 00:28:06.980 align:middle line:90% And this is in billions. 00:28:06.980 --> 00:28:10.485 align:middle line:90% So these guys here-- 00:28:10.485 --> 00:28:14.270 align:middle line:84% this, China and Canada have the largest, and the UK, 00:28:14.270 --> 00:28:19.490 align:middle line:84% those have on the order of $2 trillion of US 00:28:19.490 --> 00:28:23.505 align:middle line:84% assets they're holding Japan should be here also. 00:28:23.505 --> 00:28:24.290 align:middle line:90% Yeah, there it is. 00:28:24.290 --> 00:28:26.230 align:middle line:90% Yeah. 00:28:26.230 --> 00:28:30.260 align:middle line:84% Now in these two countries here, a lot 00:28:30.260 --> 00:28:32.720 align:middle line:90% of those holdings actually-- 00:28:32.720 --> 00:28:36.340 align:middle line:84% well, particularly in China more than in Japan. 00:28:36.340 --> 00:28:38.330 align:middle line:84% In China it's a little less than Japan. 00:28:38.330 --> 00:28:42.020 align:middle line:84% Japan, they save a lot so they need 00:28:42.020 --> 00:28:43.880 align:middle line:84% to buy lots of financial assets and the US 00:28:43.880 --> 00:28:48.500 align:middle line:84% is the main producer of financial assets in the world. 00:28:48.500 --> 00:28:49.700 align:middle line:90% They save a lot on that. 00:28:49.700 --> 00:28:53.370 align:middle line:84% But also the central bank, because of currency intervention 00:28:53.370 --> 00:28:56.090 align:middle line:84% and so on, buys lots of US treasuries. 00:28:56.090 --> 00:28:59.180 align:middle line:84% China, this is mostly the central bank 00:28:59.180 --> 00:29:02.120 align:middle line:84% buying US treasuries, foreign reserves, 00:29:02.120 --> 00:29:04.400 align:middle line:90% large amounts of reserves. 00:29:04.400 --> 00:29:07.550 align:middle line:84% Canada is private sector, pension funds and so on, 00:29:07.550 --> 00:29:08.850 align:middle line:90% probably. 00:29:08.850 --> 00:29:13.080 align:middle line:84% But you see, Brazilians also buy lots of assets from the US. 00:29:13.080 --> 00:29:16.170 align:middle line:84% Again, central banks play big roles in all this. 00:29:16.170 --> 00:29:20.040 align:middle line:84% Australia is less a central bank, much more private sector. 00:29:20.040 --> 00:29:23.900 align:middle line:84% UK is all private sector, and so on. 00:29:23.900 --> 00:29:24.810 align:middle line:90% And in Europe. 00:29:24.810 --> 00:29:25.310 align:middle line:90% OK. 00:29:25.310 --> 00:29:27.490 align:middle line:84% But the point of that picture is that there 00:29:27.490 --> 00:29:29.215 align:middle line:84% are lots of countries in the world 00:29:29.215 --> 00:29:31.570 align:middle line:84% or residents of different countries in the world 00:29:31.570 --> 00:29:34.660 align:middle line:84% that buy US financial assets and in big amounts. 00:29:34.660 --> 00:29:36.490 align:middle line:90% OK? 00:29:36.490 --> 00:29:38.710 align:middle line:84% I don't know what the total number today is. 00:29:38.710 --> 00:29:47.160 align:middle line:90% Probably-- eh. 00:29:47.160 --> 00:29:50.020 align:middle line:84% Actually, let me not make up that number. 00:29:50.020 --> 00:29:50.970 align:middle line:90% You may find it. 00:29:50.970 --> 00:29:53.480 align:middle line:90% 00:29:53.480 --> 00:29:57.200 align:middle line:84% But it is certainly in the $20 trillion 00:29:57.200 --> 00:29:59.550 align:middle line:84% or something like that of assets held-- 00:29:59.550 --> 00:30:02.740 align:middle line:90% US assets held by foreigners. 00:30:02.740 --> 00:30:05.130 align:middle line:90% You can check it and tell me. 00:30:05.130 --> 00:30:07.360 align:middle line:90% It's probably more. 00:30:07.360 --> 00:30:09.000 align:middle line:90% Here's the other way around. 00:30:09.000 --> 00:30:12.895 align:middle line:84% US residents holdings of foreign assets. 00:30:12.895 --> 00:30:13.395 align:middle line:90% OK. 00:30:13.395 --> 00:30:16.500 align:middle line:90% 00:30:16.500 --> 00:30:24.273 align:middle line:84% You see, US residents hold lots of Canadian assets and mostly 00:30:24.273 --> 00:30:25.690 align:middle line:84% developed economies, but there you 00:30:25.690 --> 00:30:28.930 align:middle line:90% have India, China, and so on. 00:30:28.930 --> 00:30:33.740 align:middle line:84% Lots of Latin American assets and so on. 00:30:33.740 --> 00:30:35.050 align:middle line:90% OK. 00:30:35.050 --> 00:30:38.830 align:middle line:84% So the US-- so it's not only that the rest of the world 00:30:38.830 --> 00:30:44.080 align:middle line:84% demands US assets, but US residents-- 00:30:44.080 --> 00:30:45.970 align:middle line:84% perhaps not directly, most of you, 00:30:45.970 --> 00:30:49.040 align:middle line:84% but indirectly demand lots of foreign assets. 00:30:49.040 --> 00:30:51.070 align:middle line:90% OK. 00:30:51.070 --> 00:30:52.900 align:middle line:84% There are some very fascinating facts 00:30:52.900 --> 00:30:54.790 align:middle line:84% that happen here because the type of assets 00:30:54.790 --> 00:30:56.620 align:middle line:84% that foreigners tend to demand from the US 00:30:56.620 --> 00:31:01.240 align:middle line:84% are very different from the ones the US demands 00:31:01.240 --> 00:31:04.190 align:middle line:90% from the rest of the world. 00:31:04.190 --> 00:31:06.470 align:middle line:84% In fact, one of the things that-- 00:31:06.470 --> 00:31:10.970 align:middle line:84% the reasons the US can afford running those chronic trade 00:31:10.970 --> 00:31:14.780 align:middle line:84% deficits is because it tends to get much higher returns 00:31:14.780 --> 00:31:17.420 align:middle line:84% on the assets it buys abroad than foreigners 00:31:17.420 --> 00:31:19.970 align:middle line:84% get on the assets they buy in the US. 00:31:19.970 --> 00:31:25.250 align:middle line:84% The difference allows you to fund systematic trade deficits. 00:31:25.250 --> 00:31:27.560 align:middle line:84% And the reason for that is a lot of the US assets 00:31:27.560 --> 00:31:30.500 align:middle line:84% that foreigners buy, they do it for safety reasons. 00:31:30.500 --> 00:31:32.960 align:middle line:84% They are buying US treasuries, very safe instruments. 00:31:32.960 --> 00:31:35.030 align:middle line:84% Just in case there is a big mess, 00:31:35.030 --> 00:31:38.030 align:middle line:84% they want to have those assets, so it's almost 00:31:38.030 --> 00:31:40.580 align:middle line:90% for insurance reason. 00:31:40.580 --> 00:31:44.420 align:middle line:84% The US treasuries are sort of perceived as a main safe assets 00:31:44.420 --> 00:31:45.570 align:middle line:90% in the world. 00:31:45.570 --> 00:31:48.170 align:middle line:90% So they hold it for that reason. 00:31:48.170 --> 00:31:55.670 align:middle line:84% While the US mostly holds assets abroad for risky investments. 00:31:55.670 --> 00:32:00.120 align:middle line:84% Either foreign direct investment or equity, stuff like that. 00:32:00.120 --> 00:32:04.430 align:middle line:84% And typically most fixed income investors in the US-- 00:32:04.430 --> 00:32:09.200 align:middle line:84% a lot of what you see here is just US residents 00:32:09.200 --> 00:32:12.500 align:middle line:90% reaching for yield. 00:32:12.500 --> 00:32:16.820 align:middle line:84% Brazilian sovereign bonds, the equivalent of the US treasuries 00:32:16.820 --> 00:32:19.190 align:middle line:90% give you 9%, 10%. 00:32:19.190 --> 00:32:21.920 align:middle line:84% It's a lot higher than the US tends to give. 00:32:21.920 --> 00:32:25.430 align:middle line:90% 14% even now, and so on. 00:32:25.430 --> 00:32:29.840 align:middle line:84% So on net, the US tends to make-- 00:32:29.840 --> 00:32:32.240 align:middle line:84% has less assets in the rest of the world 00:32:32.240 --> 00:32:35.330 align:middle line:84% than foreigners have of the US and it still 00:32:35.330 --> 00:32:39.200 align:middle line:84% makes sufficiently more return, higher return on average 00:32:39.200 --> 00:32:41.150 align:middle line:84% on an asset it holds on the rest of the world 00:32:41.150 --> 00:32:45.440 align:middle line:84% that it has a surplus which it can finance the trade deficit. 00:32:45.440 --> 00:32:46.610 align:middle line:90% This is complicated. 00:32:46.610 --> 00:32:48.068 align:middle line:84% You don't need to know the details, 00:32:48.068 --> 00:32:50.840 align:middle line:84% but just to tell you what the kind of things are happening. 00:32:50.840 --> 00:32:54.580 align:middle line:90% 00:32:54.580 --> 00:32:59.800 align:middle line:84% So there's three senses in which you can have openness. 00:32:59.800 --> 00:33:03.310 align:middle line:84% The two that have described implicitly already, goods. 00:33:03.310 --> 00:33:06.910 align:middle line:84% In goods market you can buy foreign goods 00:33:06.910 --> 00:33:09.740 align:middle line:84% and you can sell goods to the rest of the world. 00:33:09.740 --> 00:33:11.898 align:middle line:84% And the second one is financial markets, 00:33:11.898 --> 00:33:13.190 align:middle line:90% which is what I just described. 00:33:13.190 --> 00:33:17.250 align:middle line:84% You can choose between domestic and foreign assets. 00:33:17.250 --> 00:33:19.140 align:middle line:84% The main impediments to the former 00:33:19.140 --> 00:33:21.090 align:middle line:84% typically are tariffs and quotas, 00:33:21.090 --> 00:33:25.410 align:middle line:84% and you have heard a lot about tariffs and so on these days. 00:33:25.410 --> 00:33:27.720 align:middle line:84% The main impediments for financial markets 00:33:27.720 --> 00:33:29.250 align:middle line:84% is what is called capital controls. 00:33:29.250 --> 00:33:34.180 align:middle line:84% Very rarely developed economies impose capital controls, 00:33:34.180 --> 00:33:36.470 align:middle line:84% but emerging markets do it regularly. 00:33:36.470 --> 00:33:37.960 align:middle line:90% OK? 00:33:37.960 --> 00:33:40.240 align:middle line:84% Limit the amount of-- especially capital outflows. 00:33:40.240 --> 00:33:42.190 align:middle line:84% When lots of capital is live in the country, 00:33:42.190 --> 00:33:45.760 align:middle line:84% they try to stop you from doing more of that. 00:33:45.760 --> 00:33:47.830 align:middle line:84% And they sometimes do it in the way 00:33:47.830 --> 00:33:51.940 align:middle line:84% in because they want to avoid the macro instability that 00:33:51.940 --> 00:33:54.290 align:middle line:84% comes from the big reversal of capital flows, 00:33:54.290 --> 00:33:55.900 align:middle line:84% so they don't let lots of capital flow 00:33:55.900 --> 00:34:00.370 align:middle line:84% in during the boom just to prevent a reversal later on. 00:34:00.370 --> 00:34:02.300 align:middle line:90% Thus capital controls. 00:34:02.300 --> 00:34:04.390 align:middle line:84% And there is a third way of opening 00:34:04.390 --> 00:34:08.139 align:middle line:84% to the rest of the world, which is factor markets. 00:34:08.139 --> 00:34:08.920 align:middle line:90% OK? 00:34:08.920 --> 00:34:11.290 align:middle line:84% Which is that firms can choose location. 00:34:11.290 --> 00:34:12.670 align:middle line:90% I mean, some plants-- 00:34:12.670 --> 00:34:19.449 align:middle line:84% we're seeing Japanese plants that do not export Toyotas 00:34:19.449 --> 00:34:23.409 align:middle line:90% directly from Japan. 00:34:23.409 --> 00:34:26.889 align:middle line:84% They have the plant here either in Canada or somewhere in the US 00:34:26.889 --> 00:34:28.270 align:middle line:90% and they sell locally. 00:34:28.270 --> 00:34:31.030 align:middle line:84% So that's relocation of factors of production. 00:34:31.030 --> 00:34:34.489 align:middle line:84% Japanese capital that relocates to some place in Canada 00:34:34.489 --> 00:34:36.590 align:middle line:90% or in the US, and labor. 00:34:36.590 --> 00:34:39.409 align:middle line:84% You can also have workers that move from one place 00:34:39.409 --> 00:34:40.280 align:middle line:90% to the other. 00:34:40.280 --> 00:34:43.850 align:middle line:90% That's another form of openness. 00:34:43.850 --> 00:34:48.949 align:middle line:90% Free factor mobility. 00:34:48.949 --> 00:34:52.370 align:middle line:84% In this part of the course we're not going to talk about this. 00:34:52.370 --> 00:34:53.929 align:middle line:90% OK? 00:34:53.929 --> 00:34:56.797 align:middle line:84% We're going to focus on these two. 00:34:56.797 --> 00:34:58.380 align:middle line:84% The first model we're going to look at 00:34:58.380 --> 00:35:00.172 align:middle line:84% is going to be a model of the goods market, 00:35:00.172 --> 00:35:05.400 align:middle line:84% and that's going to be very much like the IS-LM 00:35:05.400 --> 00:35:07.200 align:middle line:90% but with an open economy. 00:35:07.200 --> 00:35:10.420 align:middle line:84% And then we're going to bring in interest rates, 00:35:10.420 --> 00:35:12.178 align:middle line:90% but now once you-- 00:35:12.178 --> 00:35:14.220 align:middle line:84% remember what we did in the closed economy first? 00:35:14.220 --> 00:35:15.678 align:middle line:84% We looked at the goods market, then 00:35:15.678 --> 00:35:17.310 align:middle line:84% we look at interest rate determination. 00:35:17.310 --> 00:35:18.570 align:middle line:90% That was our LM. 00:35:18.570 --> 00:35:21.810 align:middle line:84% And then we put the things together, we came up with IS-LM. 00:35:21.810 --> 00:35:24.550 align:middle line:84% Here the tricky thing is that there is not only 00:35:24.550 --> 00:35:25.300 align:middle line:90% one interest rate. 00:35:25.300 --> 00:35:26.070 align:middle line:90% There are really two. 00:35:26.070 --> 00:35:27.695 align:middle line:84% You have to decide between the domestic 00:35:27.695 --> 00:35:29.730 align:middle line:84% and the foreign interest rate, and then there 00:35:29.730 --> 00:35:32.070 align:middle line:84% is an exchange rate in between which will also affect. 00:35:32.070 --> 00:35:33.150 align:middle line:84% So that's the reason it's going to get 00:35:33.150 --> 00:35:35.130 align:middle line:84% a little more complicated, because you're 00:35:35.130 --> 00:35:37.990 align:middle line:84% going to be having two different prices, two different goods you 00:35:37.990 --> 00:35:38.490 align:middle line:90% can buy. 00:35:38.490 --> 00:35:42.060 align:middle line:84% You're going to have also two different assets you can buy. 00:35:42.060 --> 00:35:45.420 align:middle line:84% And the effects is going to affect all those things. 00:35:45.420 --> 00:35:48.940 align:middle line:84% Whenever I say effects, I mean the exchange rate. 00:35:48.940 --> 00:35:51.130 align:middle line:90% OK? 00:35:51.130 --> 00:35:52.060 align:middle line:90% Foreign exchange. 00:35:52.060 --> 00:35:56.710 align:middle line:84% That's the reason sometimes it's called FX. 00:35:56.710 --> 00:36:02.080 align:middle line:84% Now one thing that happens is that because economies 00:36:02.080 --> 00:36:06.280 align:middle line:84% are so integrated in goods and financial markets is 00:36:06.280 --> 00:36:08.200 align:middle line:90% that business cycles tend to-- 00:36:08.200 --> 00:36:10.780 align:middle line:84% especially large ones tend to be very 00:36:10.780 --> 00:36:12.370 align:middle line:90% synchronized around the world. 00:36:12.370 --> 00:36:14.410 align:middle line:90% You see here emerging markets. 00:36:14.410 --> 00:36:17.570 align:middle line:90% 00:36:17.570 --> 00:36:18.300 align:middle line:90% Sorry. 00:36:18.300 --> 00:36:18.800 align:middle line:90% Yeah. 00:36:18.800 --> 00:36:19.550 align:middle line:90% This is the world. 00:36:19.550 --> 00:36:24.140 align:middle line:84% That's emerging markets and that's advanced economies. 00:36:24.140 --> 00:36:26.780 align:middle line:84% You can see the kind of things we discussed in the growth 00:36:26.780 --> 00:36:28.700 align:middle line:84% section, which is these countries tend 00:36:28.700 --> 00:36:30.500 align:middle line:84% to grow faster than these countries 00:36:30.500 --> 00:36:33.200 align:middle line:90% because they're catching up. 00:36:33.200 --> 00:36:36.410 align:middle line:84% That's the reason they're called emerging. 00:36:36.410 --> 00:36:39.080 align:middle line:84% But the level of the business cycle, they're 00:36:39.080 --> 00:36:39.830 align:middle line:90% very synchronized. 00:36:39.830 --> 00:36:42.590 align:middle line:90% I mean, there's 2008, 2009. 00:36:42.590 --> 00:36:45.680 align:middle line:84% The recession was a recession globally. 00:36:45.680 --> 00:36:48.770 align:middle line:84% This one doesn't have COVID, but, well, COVID very naturally 00:36:48.770 --> 00:36:52.700 align:middle line:84% was very synchronized around the world. 00:36:52.700 --> 00:36:56.060 align:middle line:84% The point I'm making here is that once you're very integrated 00:36:56.060 --> 00:36:58.157 align:middle line:84% to the rest of the world, you're also exposed 00:36:58.157 --> 00:36:59.240 align:middle line:90% to a new source of shocks. 00:36:59.240 --> 00:37:00.740 align:middle line:84% It may help you in many instances, 00:37:00.740 --> 00:37:03.050 align:middle line:84% but you're also exposed to things that come 00:37:03.050 --> 00:37:05.450 align:middle line:90% from the rest of the world. 00:37:05.450 --> 00:37:07.400 align:middle line:84% And the evidence is that business cycles 00:37:07.400 --> 00:37:09.060 align:middle line:90% are very synchronized. 00:37:09.060 --> 00:37:12.170 align:middle line:84% It's very difficult for the rest of the world 00:37:12.170 --> 00:37:14.760 align:middle line:84% to be immune to a US recession, for example. 00:37:14.760 --> 00:37:16.670 align:middle line:84% It's very easy for the US to be immune 00:37:16.670 --> 00:37:18.915 align:middle line:90% to an Argentinian recession. 00:37:18.915 --> 00:37:21.330 align:middle line:90% That's a different story. 00:37:21.330 --> 00:37:23.640 align:middle line:84% But when things are large, involve 00:37:23.640 --> 00:37:25.140 align:middle line:84% the large economies, typically that 00:37:25.140 --> 00:37:27.430 align:middle line:84% will leak into the rest of the world. 00:37:27.430 --> 00:37:30.210 align:middle line:84% China has changed a little bit the composition. 00:37:30.210 --> 00:37:33.090 align:middle line:84% It used to be the case that that was always the case. 00:37:33.090 --> 00:37:38.274 align:middle line:84% If the US sank, then everyone sank. 00:37:38.274 --> 00:37:42.100 align:middle line:84% And now you have China, which stabilizes-- it's different. 00:37:42.100 --> 00:37:45.210 align:middle line:84% It's not completely correlated with the US, 00:37:45.210 --> 00:37:47.250 align:middle line:84% and so that has been stabilizing, actually, 00:37:47.250 --> 00:37:50.890 align:middle line:84% for many especially commodity producing economies and so on. 00:37:50.890 --> 00:37:51.900 align:middle line:90% But it's still the case. 00:37:51.900 --> 00:37:53.670 align:middle line:84% Big mess is a big mess everywhere. 00:37:53.670 --> 00:37:55.170 align:middle line:84% If the economists were closed, there 00:37:55.170 --> 00:37:58.553 align:middle line:84% would be no reason unless you have some exogenous shock. 00:37:58.553 --> 00:38:00.720 align:middle line:84% COVID, even if the economies were completely closed, 00:38:00.720 --> 00:38:05.310 align:middle line:84% would have been a mess because as long as the virus is spread, 00:38:05.310 --> 00:38:07.020 align:middle line:90% then it's a mess regardless. 00:38:07.020 --> 00:38:08.530 align:middle line:90% But that's not the case here. 00:38:08.530 --> 00:38:12.710 align:middle line:84% This recession was caused by a financial shock in the US. 00:38:12.710 --> 00:38:13.340 align:middle line:90% OK? 00:38:13.340 --> 00:38:18.330 align:middle line:84% And still, the global economy as a whole suffer a lot. 00:38:18.330 --> 00:38:22.460 align:middle line:84% So things become very synchronized because of that. 00:38:22.460 --> 00:38:26.680 align:middle line:84% Another thing that has been happening is that everywhere-- 00:38:26.680 --> 00:38:31.330 align:middle line:84% again, we shall see where we end up after this COVID things. 00:38:31.330 --> 00:38:33.130 align:middle line:84% There was a slight reversion of that. 00:38:33.130 --> 00:38:35.620 align:middle line:84% But everywhere, even the US, which is one of the 00:38:35.620 --> 00:38:37.280 align:middle line:90% closed economies in the world-- 00:38:37.280 --> 00:38:40.510 align:middle line:84% one of the closed of the significant economies, 00:38:40.510 --> 00:38:43.870 align:middle line:84% there has been a sort of-- there was a steady trend rise 00:38:43.870 --> 00:38:47.312 align:middle line:84% towards higher integration to the rest of the world. 00:38:47.312 --> 00:38:49.270 align:middle line:84% And the same is happening in financial markets. 00:38:49.270 --> 00:38:52.210 align:middle line:84% This is just an order of money larger. 00:38:52.210 --> 00:38:55.750 align:middle line:84% But you see here in the US, you see that imports and exports 00:38:55.750 --> 00:38:58.840 align:middle line:84% as a share of GDP, they were both rising over time. 00:38:58.840 --> 00:39:00.890 align:middle line:84% Here shows you what I showed you before, 00:39:00.890 --> 00:39:03.670 align:middle line:84% which is the deficit, chronic deficit that the US has had. 00:39:03.670 --> 00:39:07.810 align:middle line:84% But still, even exports have been rising for a while. 00:39:07.810 --> 00:39:15.080 align:middle line:84% Now this number here, you know that about 20% of the US 00:39:15.080 --> 00:39:22.670 align:middle line:84% produced goods of 15% of GDP, The US has about 15% of GDP 00:39:22.670 --> 00:39:24.470 align:middle line:90% in imports and in exports. 00:39:24.470 --> 00:39:27.170 align:middle line:84% Some people use that, the sum, for example, 00:39:27.170 --> 00:39:30.350 align:middle line:84% of imports plus exports over GDP as a measure of openness, 00:39:30.350 --> 00:39:32.060 align:middle line:90% how open is an economy. 00:39:32.060 --> 00:39:35.930 align:middle line:84% And it's OK for comparisons, but it's clearly underestimated 00:39:35.930 --> 00:39:38.390 align:middle line:90% how open economies really are. 00:39:38.390 --> 00:39:40.550 align:middle line:84% I mean, many of the goods that are considered-- 00:39:40.550 --> 00:39:45.860 align:middle line:84% that the US does not import are produced domestically 00:39:45.860 --> 00:39:48.040 align:middle line:84% so they don't count as part of imports or anything. 00:39:48.040 --> 00:39:52.240 align:middle line:84% Their price is really determined by international competition. 00:39:52.240 --> 00:39:53.290 align:middle line:90% OK? 00:39:53.290 --> 00:39:56.830 align:middle line:84% The price of a Ford is very different with 00:39:56.830 --> 00:39:58.610 align:middle line:90% foreign competition than not. 00:39:58.610 --> 00:40:01.660 align:middle line:84% So we don't count the Fords produced here 00:40:01.660 --> 00:40:07.282 align:middle line:84% as imports or anything and it was part of the non-tradable. 00:40:07.282 --> 00:40:07.990 align:middle line:90% Not non-tradable. 00:40:07.990 --> 00:40:10.210 align:middle line:84% It wasn't part of this measure of openness. 00:40:10.210 --> 00:40:13.900 align:middle line:84% But it's clear that the price and even the quality 00:40:13.900 --> 00:40:17.645 align:middle line:84% is being affected by exposure to international competition. 00:40:17.645 --> 00:40:20.020 align:middle line:84% So there are very few sectors that are not really exposed 00:40:20.020 --> 00:40:21.640 align:middle line:90% to international competition. 00:40:21.640 --> 00:40:22.960 align:middle line:90% Yeah, haircuts. 00:40:22.960 --> 00:40:23.560 align:middle line:90% They're not. 00:40:23.560 --> 00:40:26.290 align:middle line:90% I mean, you're not going to-- 00:40:26.290 --> 00:40:32.980 align:middle line:84% unless you live in some county at the border of Canada 00:40:32.980 --> 00:40:35.680 align:middle line:84% and there is a town right on the other side, 00:40:35.680 --> 00:40:38.520 align:middle line:90% that's not going to happen. 00:40:38.520 --> 00:40:39.570 align:middle line:90% OK. 00:40:39.570 --> 00:40:44.040 align:middle line:84% So trend is upward, and even more so 00:40:44.040 --> 00:40:47.060 align:middle line:90% than those numbers suggest. 00:40:47.060 --> 00:40:49.520 align:middle line:84% If you look across the world, here 00:40:49.520 --> 00:40:51.800 align:middle line:90% is what I showed you before-- 00:40:51.800 --> 00:40:57.380 align:middle line:84% what I said before is that the US actually certainly looks 00:40:57.380 --> 00:40:58.890 align:middle line:90% very close relative to others. 00:40:58.890 --> 00:41:02.580 align:middle line:84% If you look across large economies, Japan, 00:41:02.580 --> 00:41:04.730 align:middle line:84% which is also very closed economy for a variety 00:41:04.730 --> 00:41:10.020 align:middle line:84% of reasons, it's still more open than the US, UK, little Chile 00:41:10.020 --> 00:41:10.520 align:middle line:90% here. 00:41:10.520 --> 00:41:13.145 align:middle line:90% 00:41:13.145 --> 00:41:16.370 align:middle line:84% One thing that this shows, this dimension here shows 00:41:16.370 --> 00:41:20.558 align:middle line:84% is that the smaller you are, the more open you're likely to be. 00:41:20.558 --> 00:41:21.350 align:middle line:90% And it makes sense. 00:41:21.350 --> 00:41:23.240 align:middle line:84% It's harder to produce all the goods 00:41:23.240 --> 00:41:24.950 align:middle line:90% if you have a small country. 00:41:24.950 --> 00:41:27.560 align:middle line:90% 00:41:27.560 --> 00:41:29.150 align:middle line:90% So that's a pattern. 00:41:29.150 --> 00:41:33.920 align:middle line:84% The smaller you are, controlling for a variety of factors, 00:41:33.920 --> 00:41:35.580 align:middle line:90% you tend to be more open. 00:41:35.580 --> 00:41:38.900 align:middle line:84% You need to import and export more. 00:41:38.900 --> 00:41:42.170 align:middle line:90% Import more, in particular. 00:41:42.170 --> 00:41:45.890 align:middle line:84% Now, that pattern is disrupted when 00:41:45.890 --> 00:41:49.200 align:middle line:90% you look in this direction, no? 00:41:49.200 --> 00:41:54.840 align:middle line:84% So all these countries, which are clearly 00:41:54.840 --> 00:42:00.490 align:middle line:84% much larger than Chile in terms of GDP and so on, 00:42:00.490 --> 00:42:02.865 align:middle line:90% have very high export ratios. 00:42:02.865 --> 00:42:04.240 align:middle line:84% Why do you think that's the case? 00:42:04.240 --> 00:42:11.380 align:middle line:90% 00:42:11.380 --> 00:42:12.390 align:middle line:90% Yeah? 00:42:12.390 --> 00:42:13.240 align:middle line:90% AUDIENCE: Europe. 00:42:13.240 --> 00:42:13.780 align:middle line:90% RICARDO CABALLERO: Exactly. 00:42:13.780 --> 00:42:14.585 align:middle line:90% They are in Europe. 00:42:14.585 --> 00:42:17.980 align:middle line:90% 00:42:17.980 --> 00:42:19.600 align:middle line:90% Europe is very special. 00:42:19.600 --> 00:42:22.900 align:middle line:84% Europe as a whole is as closed as the US. 00:42:22.900 --> 00:42:25.570 align:middle line:84% So if you look at the whole area together. 00:42:25.570 --> 00:42:28.120 align:middle line:84% But there is lots of intra-Europe exports 00:42:28.120 --> 00:42:30.040 align:middle line:84% and imports, especially in the Eurozone. 00:42:30.040 --> 00:42:33.931 align:middle line:84% I mean, you have lots of things that have the same currency. 00:42:33.931 --> 00:42:36.340 align:middle line:90% It's right next door. 00:42:36.340 --> 00:42:39.850 align:middle line:84% So they're very open, but they're very open within Europe, 00:42:39.850 --> 00:42:44.230 align:middle line:84% not so much with the rest of the world 00:42:44.230 --> 00:42:48.670 align:middle line:84% But this doesn't differentiate intra-Europe exports and imports 00:42:48.670 --> 00:42:50.470 align:middle line:90% versus total. 00:42:50.470 --> 00:42:53.170 align:middle line:84% That's the reason you see these numbers are very, very large. 00:42:53.170 --> 00:42:56.260 align:middle line:84% But even here, within here, you see that the smaller countries 00:42:56.260 --> 00:42:57.880 align:middle line:90% tend to be very open. 00:42:57.880 --> 00:43:01.240 align:middle line:84% Much more open than bigger countries. 00:43:01.240 --> 00:43:03.850 align:middle line:90% OK? 00:43:03.850 --> 00:43:04.350 align:middle line:90% Good. 00:43:04.350 --> 00:43:06.920 align:middle line:90% 00:43:06.920 --> 00:43:11.450 align:middle line:90% So as I said, so terminology. 00:43:11.450 --> 00:43:14.600 align:middle line:84% This picture looks very similar to the picture I showed you 00:43:14.600 --> 00:43:16.670 align:middle line:90% earlier on, but it's not. 00:43:16.670 --> 00:43:20.450 align:middle line:84% There it was a trade weighted dollar, 00:43:20.450 --> 00:43:23.900 align:middle line:84% and here it's just one particular bilateral exchange, 00:43:23.900 --> 00:43:26.360 align:middle line:84% which is the dollar-yen exchange rate. 00:43:26.360 --> 00:43:28.380 align:middle line:84% What happens is when the dollar appreciates, 00:43:28.380 --> 00:43:30.630 align:middle line:84% typically it appreciates against everything and so on. 00:43:30.630 --> 00:43:32.672 align:middle line:84% That's the reason the pictures look very similar. 00:43:32.672 --> 00:43:34.640 align:middle line:90% But this was pretty dramatic. 00:43:34.640 --> 00:43:38.960 align:middle line:84% There was a very sharp appreciation of the dollar-- 00:43:38.960 --> 00:43:42.080 align:middle line:90% well, strike what I said. 00:43:42.080 --> 00:43:46.790 align:middle line:84% So anyways, this is the pattern of the number of yen's per 00:43:46.790 --> 00:43:47.930 align:middle line:90% dollar's. 00:43:47.930 --> 00:43:49.562 align:middle line:84% Meaning we decided that that's the way 00:43:49.562 --> 00:43:51.020 align:middle line:84% we're going to define exchange this 00:43:51.020 --> 00:43:52.970 align:middle line:84% the price of the domestic currency 00:43:52.970 --> 00:43:54.570 align:middle line:90% in terms of foreign currency. 00:43:54.570 --> 00:43:58.010 align:middle line:84% So the price of the US dollar goes up 00:43:58.010 --> 00:44:01.220 align:middle line:84% when they pay you more yen's per dollar. 00:44:01.220 --> 00:44:04.550 align:middle line:84% And it went up very rapidly from close to 100 to 150. 00:44:04.550 --> 00:44:05.690 align:middle line:90% That was massive. 00:44:05.690 --> 00:44:07.290 align:middle line:84% There were massive interventions here 00:44:07.290 --> 00:44:11.910 align:middle line:84% because it was clear that this was getting totally out of hand. 00:44:11.910 --> 00:44:14.080 align:middle line:90% But anyway, so that was-- 00:44:14.080 --> 00:44:14.580 align:middle line:90% OK. 00:44:14.580 --> 00:44:17.430 align:middle line:90% And we say in this case-- 00:44:17.430 --> 00:44:19.850 align:middle line:84% so when a currency gains in value, 00:44:19.850 --> 00:44:22.577 align:middle line:84% we call that, in terms of other currencies-- 00:44:22.577 --> 00:44:24.410 align:middle line:84% there's no sense of a currency gaining value 00:44:24.410 --> 00:44:25.333 align:middle line:90% in terms of nothing. 00:44:25.333 --> 00:44:27.000 align:middle line:84% It has to be in terms of other currency. 00:44:27.000 --> 00:44:28.780 align:middle line:90% That's what an exchange rate is. 00:44:28.780 --> 00:44:31.770 align:middle line:84% So we say that the currency is appreciating. 00:44:31.770 --> 00:44:32.270 align:middle line:90% OK? 00:44:32.270 --> 00:44:34.950 align:middle line:84% So in this case, it's a nominal exchange rate, 00:44:34.950 --> 00:44:36.080 align:middle line:90% so it's dollars per dollar. 00:44:36.080 --> 00:44:39.050 align:middle line:90% 00:44:39.050 --> 00:44:40.710 align:middle line:84% When the dollar is going up here, 00:44:40.710 --> 00:44:43.400 align:middle line:84% we say the dollar is appreciating relative 00:44:43.400 --> 00:44:45.030 align:middle line:90% to the Japanese yen. 00:44:45.030 --> 00:44:45.530 align:middle line:90% OK? 00:44:45.530 --> 00:44:47.300 align:middle line:84% That means the dollar is becoming more expensive. 00:44:47.300 --> 00:44:49.400 align:middle line:84% They have to give you more gains per dollar. 00:44:49.400 --> 00:44:52.070 align:middle line:84% You can look at it from the point of view of Japan, 00:44:52.070 --> 00:44:54.560 align:middle line:84% and then the picture would look the other way around 00:44:54.560 --> 00:44:56.580 align:middle line:84% and it says in this same picture, 00:44:56.580 --> 00:45:00.380 align:middle line:84% I know that the Japanese yen is depreciating relative 00:45:00.380 --> 00:45:02.010 align:middle line:90% to the US dollar. 00:45:02.010 --> 00:45:02.510 align:middle line:90% OK? 00:45:02.510 --> 00:45:04.970 align:middle line:84% So depreciation is when your currency loses value. 00:45:04.970 --> 00:45:07.055 align:middle line:84% Appreciation is when your currency gains value. 00:45:07.055 --> 00:45:13.590 align:middle line:90% 00:45:13.590 --> 00:45:15.570 align:middle line:90% I mean, if I tell you-- 00:45:15.570 --> 00:45:19.260 align:middle line:84% unless you more or less know the prices in the different places, 00:45:19.260 --> 00:45:24.210 align:middle line:84% if I tell you that the Japanese-- 00:45:24.210 --> 00:45:29.680 align:middle line:84% the US buys 130 Japanese yen, you can tell me-- 00:45:29.680 --> 00:45:32.810 align:middle line:84% and then I ask you, where would you like to buy your car? 00:45:32.810 --> 00:45:34.560 align:middle line:84% I assume that the car is the same quality. 00:45:34.560 --> 00:45:36.550 align:middle line:90% No transport costs and so on. 00:45:36.550 --> 00:45:40.110 align:middle line:84% And I tell you, look, the Japanese yen is-- 00:45:40.110 --> 00:45:43.457 align:middle line:84% for each dollar you get 120, 130 Japanese yen. 00:45:43.457 --> 00:45:44.915 align:middle line:84% Where do you want to buy your cars? 00:45:44.915 --> 00:45:48.350 align:middle line:90% 00:45:48.350 --> 00:45:49.350 align:middle line:90% That's the right answer. 00:45:49.350 --> 00:45:50.210 align:middle line:90% You have no clue. 00:45:50.210 --> 00:45:53.400 align:middle line:90% That doesn't tell you anything. 00:45:53.400 --> 00:45:54.860 align:middle line:84% The nominal exchange it tells you 00:45:54.860 --> 00:45:57.380 align:middle line:84% the relative value of currencies, 00:45:57.380 --> 00:45:59.720 align:middle line:84% but to make the decision of where you buy your car, 00:45:59.720 --> 00:46:02.510 align:middle line:84% you need to know which car is more expensive. 00:46:02.510 --> 00:46:07.070 align:middle line:84% That's not enough to know the exchange, the nominal exchange. 00:46:07.070 --> 00:46:10.340 align:middle line:84% You need to know what is the price of the car in each place 00:46:10.340 --> 00:46:11.450 align:middle line:90% in its own currency. 00:46:11.450 --> 00:46:14.150 align:middle line:84% And then I'm going to use the exchange rate to translate them 00:46:14.150 --> 00:46:15.680 align:middle line:90% into some common currency. 00:46:15.680 --> 00:46:20.840 align:middle line:84% Suppose I tell you now that the price of-- 00:46:20.840 --> 00:46:22.250 align:middle line:90% I do the opposite experiment. 00:46:22.250 --> 00:46:29.540 align:middle line:84% I say, look, the price of the same car in Japan is a 150,000 00:46:29.540 --> 00:46:32.720 align:middle line:90% yens. 00:46:32.720 --> 00:46:37.850 align:middle line:84% Well, there you all have lots of zeros, but a 150,000 yens, 00:46:37.850 --> 00:46:39.845 align:middle line:90% and in the US is 1,500. 00:46:39.845 --> 00:46:41.270 align:middle line:90% This is a used car. 00:46:41.270 --> 00:46:42.650 align:middle line:90% $1,500. 00:46:42.650 --> 00:46:44.300 align:middle line:90% And then I ask you a question. 00:46:44.300 --> 00:46:47.940 align:middle line:84% Where do you want to buy your car? 00:46:47.940 --> 00:46:50.832 align:middle line:84% You can't answer either because you don't know how to compare. 00:46:50.832 --> 00:46:52.790 align:middle line:84% Unless I give you the nominal exchange as well, 00:46:52.790 --> 00:46:56.480 align:middle line:84% you don't know how to compare those 150,000 yens versus 00:46:56.480 --> 00:46:58.050 align:middle line:90% the $1,500. 00:46:58.050 --> 00:46:59.370 align:middle line:90% So you need both. 00:46:59.370 --> 00:47:01.580 align:middle line:84% And that concept that captures both 00:47:01.580 --> 00:47:03.800 align:middle line:84% is what is called the real exchange rate. 00:47:03.800 --> 00:47:07.040 align:middle line:84% The real exchange is the sign for that, 00:47:07.040 --> 00:47:10.340 align:middle line:84% to capture where are you going to do your imports and exports. 00:47:10.340 --> 00:47:10.910 align:middle line:90% OK? 00:47:10.910 --> 00:47:16.690 align:middle line:84% And it's a relative price of two not currencies but goods. 00:47:16.690 --> 00:47:18.310 align:middle line:84% So that's what the real exchange is. 00:47:18.310 --> 00:47:22.090 align:middle line:84% It's the price of domestic goods relative to foreign goods. 00:47:22.090 --> 00:47:26.680 align:middle line:84% How many Japanese cars you give me for one car, US car? 00:47:26.680 --> 00:47:28.240 align:middle line:84% That's the real exchange rate, which 00:47:28.240 --> 00:47:31.280 align:middle line:84% is different from the nominal exchange rate. 00:47:31.280 --> 00:47:33.255 align:middle line:84% Now, it's related to the nominal exchange rate. 00:47:33.255 --> 00:47:34.630 align:middle line:84% It happens that in practice a lot 00:47:34.630 --> 00:47:37.270 align:middle line:84% of the volatility of that price is 00:47:37.270 --> 00:47:40.000 align:middle line:84% as a result of the volatility of the nominal exchange rate. 00:47:40.000 --> 00:47:40.750 align:middle line:90% Let me end this. 00:47:40.750 --> 00:47:41.900 align:middle line:90% With this, I will stop. 00:47:41.900 --> 00:47:45.460 align:middle line:84% So let me call epsilon the real exchange rate. 00:47:45.460 --> 00:47:48.050 align:middle line:84% Let me see how we're going to get to that expression here. 00:47:48.050 --> 00:47:52.090 align:middle line:84% So we want to compare here is the relative value of two goods, 00:47:52.090 --> 00:47:55.600 align:middle line:84% because that's what will matter for my consumption decision 00:47:55.600 --> 00:47:57.260 align:middle line:90% or my purchase decision. 00:47:57.260 --> 00:48:00.160 align:middle line:84% So suppose we're talking about this car, 00:48:00.160 --> 00:48:05.905 align:middle line:84% and suppose I know that the price of the car in the US is p. 00:48:05.905 --> 00:48:08.170 align:middle line:84% And now I want to compare it with-- 00:48:08.170 --> 00:48:11.140 align:middle line:84% well, do I buy it here or do I buy it in Japan? 00:48:11.140 --> 00:48:16.280 align:middle line:84% For that, I'm going to have to compare them 00:48:16.280 --> 00:48:17.580 align:middle line:90% in the same currency. 00:48:17.580 --> 00:48:19.100 align:middle line:84% So the first thing I'm going to do 00:48:19.100 --> 00:48:22.070 align:middle line:84% is I'm going to translate my US dollar 00:48:22.070 --> 00:48:26.550 align:middle line:84% price to Japanese dollar-- to yen pricing. 00:48:26.550 --> 00:48:27.050 align:middle line:90% OK? 00:48:27.050 --> 00:48:31.220 align:middle line:84% So say that I'm going to have simple numbers 00:48:31.220 --> 00:48:32.660 align:middle line:90% and they want there. 00:48:32.660 --> 00:48:35.270 align:middle line:84% So price of the car in the US costs $10,000. 00:48:35.270 --> 00:48:38.600 align:middle line:84% Suppose that for each dollar you get 10 yens. 00:48:38.600 --> 00:48:43.610 align:middle line:84% Then $10,000 times 10, that means it's 100,000 yens. 00:48:43.610 --> 00:48:47.180 align:middle line:84% So if I buy the car in the US, I pay 100,000 yens. 00:48:47.180 --> 00:48:49.070 align:middle line:90% And so now-- ah, sorry. 00:48:49.070 --> 00:48:50.990 align:middle line:84% This was not Japan in this example. 00:48:50.990 --> 00:48:51.860 align:middle line:90% It's the UK. 00:48:51.860 --> 00:48:53.100 align:middle line:90% Well, the same story. 00:48:53.100 --> 00:48:53.600 align:middle line:90% OK. 00:48:53.600 --> 00:48:55.850 align:middle line:90% And it's even simpler. 00:48:55.850 --> 00:49:03.920 align:middle line:84% It's say then the car in the US cost $10,000. 00:49:03.920 --> 00:49:08.880 align:middle line:84% Each dollar buys $0.80 or $0.80 of pounds, 00:49:08.880 --> 00:49:10.970 align:middle line:90% so that means 8,000 pounds. 00:49:10.970 --> 00:49:14.930 align:middle line:90% So the US car cost 8,000 pounds. 00:49:14.930 --> 00:49:18.710 align:middle line:84% Now compare it with a car in the UK, say, the same car, 00:49:18.710 --> 00:49:20.445 align:middle line:84% and the ratio of these two things 00:49:20.445 --> 00:49:22.070 align:middle line:84% is what we call the real exchange rate. 00:49:22.070 --> 00:49:25.460 align:middle line:84% So it's the price of the domestic good times 00:49:25.460 --> 00:49:28.430 align:middle line:84% the exchange rate divided by the foreign price, 00:49:28.430 --> 00:49:32.186 align:middle line:84% and that's the real exchange rate. 00:49:32.186 --> 00:49:37.880 align:middle line:84% If the price of the car in the UK was $9,000 and I could buy 00:49:37.880 --> 00:49:40.765 align:middle line:84% the car in the US for $8,000, I would probably buy it in the US. 00:49:40.765 --> 00:49:42.140 align:middle line:84% In practice, there are difference 00:49:42.140 --> 00:49:43.922 align:middle line:90% between the two currencies. 00:49:43.922 --> 00:49:46.130 align:middle line:84% That's the kind of thing that the real exchange means 00:49:46.130 --> 00:49:47.880 align:middle line:90% is the relative price of goods. 00:49:47.880 --> 00:49:48.380 align:middle line:90% OK? 00:49:48.380 --> 00:49:50.030 align:middle line:84% But the way to go from that is you 00:49:50.030 --> 00:49:53.180 align:middle line:84% have to multiply the nominal exchange rate times the price, 00:49:53.180 --> 00:49:56.640 align:middle line:84% because that converts it into the same currency as the price. 00:49:56.640 --> 00:49:58.260 align:middle line:90% And then you can compare them. 00:49:58.260 --> 00:50:00.570 align:middle line:90% That's the idea. 00:50:00.570 --> 00:50:03.060 align:middle line:90% So let's stop here. 00:50:03.060 --> 00:50:07.073 align:middle line:84% We're going to continue talking about open economy next week. 00:50:07.073 --> 00:50:08.490 align:middle line:84% On Wednesday, what I'm going to do 00:50:08.490 --> 00:50:14.450 align:middle line:84% is a review of IS-LM-PC and growth. 00:50:14.450 --> 00:50:27.000 align:middle line:90%