FNCE 101 Lecture Notes - Lecture 15: Leidang, Toxic Asset, Mattress
Audio 1
Audio recording started: 10:32 AM Monday, March 26, 2018
Weekly News Update
J powell update
Below 2% target --- trying to reach target
§
Median projection for unemployment rate is 3.8% 3.6% over next
2 yrs
§
Inflation projection
§
Increase in FFR will help us reach this goal of meeting
unemployment target
§
Changing target for FFR is praimary means of achieving this
§
○
Headline inflation -- price of goods and services
Core excludes volatile prices of energy and produce
§
In the long run they should be the same but headline is much
more volatile because prices of energy and produce are
determined geopolitcally or things that completely outside of
supply and demand component,natural disasters, can fluctuate
quite a bit --- just about volatility
§
○
○
Increasing FFR will slow down output as long as fFR is below target
target value-- still boosting econ above what it is
Using real int rate there is one that corresponds to potential
output
§
Fed is increasing this rate but is stil below potential output but
increasing it on the rate its going up
§
Bookmark added at 12:16 in Audio 1
§
Increase in int rate leads to higher borrowing costs (slow down in
econ) this has an impact on AD output and inflation
Econ is reaching potential, we can still be accommodative
this is why we increase int rate
□
§
Nom int rate that corresponds to neutral rate is 3% we are at 1.5
§
○
If you increase the int rate then u slow down C I AD whenever AD firms
find it hard to sell product, they slack prices this decreases inf but we
want to INCREASE it so we want to have int rate lower than what it
would be at potentila
Still increasing rate bc were still below what it will be at at
potential
§
Right now nominal FFR that corresponds to econ at potential is
3% but we are rn at 1.5-1.75 (sitlll below) MP is still
accomodative/we're still boosting econ were just boosting it less
thatn we were last because
Raised to 1.5 so there's less money in the market --- to slow
it down
We're still lower because of 2008
®
We don't want to jump back up to 3 because it will
crash the market
®
□
§
○
If we raise rate over and above potential we're throwing economy
below potential output
If consumption and investment are below potential output, firms
slack prices in order to bring back market share
Inflation will go back down □
§
All in terms of where potential would be its imporaant for fed to
understand potentila
§
○
Slide 3
US will apply tarrifs to chines imports
§
Bookmark added at 18:35 in Audio 1
§
What would happen if the US imposed tariffs on capital goods
§
○
Slide 6
Bookmark added at 24:48 in Audio 1
§
CAME FROM AN EXAM
§
Bookmark added at 28:29 in Audio 1
PART B
®
□
Bookmark added at 30:56 in Audio 1
NBR = 5
®
Borrowed reserves = 7
®
Borrow =2
®
□
Bookmark added at 33:09 in Audio 1□
§
○
Slide 13
Bookmark added at 35:35 in Audio 1
§
Go back to fisher EQ
§
How aggressive fed is at doing this is captured by the term m
§
The fed controls the nominal int rate but not the real int rate
Need to modify EQ using fisher EQ □
Fisher EQ used to transform real int rate to nominal int rate□
Nominal int rate = real + inflatoin should be equal to mb -
pit-pibar +r bar +pit
Calculate mbar pi bar r bar
®
Pi bar = central bank inf target of 2%
®
R bar = real int rate prevailing at potential = 2% ish
Linked to consumption grwoth rate and output
growth rate
◊
®
M bar = 1/2 h
®
If inf goes up by
Bookmark added at 39:01 in Audio 1
◊
Nom should go up by more than increase in
inflation bc of m and
◊
We set m to get a factor of inf rate greater
than 1
If # was 1 this would dsay that if inf rate
goes up by 1% nom int rate should go up
by 1%
}
Real int rate is 0 and youre not
controlling econ because real int rate
doesn’t change
}
In order to have impact on real int rate,
move econ, have impact on target u ned
m bar that will lead to oeff greater than 1
on inflation variable
}
If inflation goes up above 2% u need to
slow down econ
Ultimately u rslowing it down w
real int rate but tool is nom int rate
–
}
Effectively raisin gecon by 5%
Effect on C I AD and ifnlation
–
}
◊
®
□
§
○
Slide 14
Bookmark added at 41:27 in Audio 1
§
If inflation wer to rise by 1% policy response would be to raise
nom int rate by 1.5%
§
Real int rate should be raised to cool down econ when inf
increases, requiring the nominal int rate to increase more than
inf does
§
If ed were to inc int rate by less than 1% they would
accommodate inf increase which would lead to further increase
in inflation
If # was .5 (before pit)
U stimulate econ even more leading to more inflation
To fight inflatino you need to raise real rate
◊
Respond by increase in real int rate by more
than increase in inflation
◊
®
□
§
○
Slide 15
Bookmark added at 46:51 in Audio 1
§
If you plot crossed w MP rule
This graph shows how close you are to actual FFR□
§
○
Slide 16
Fed is only ajor central bank w dual mandate
§
Bookmark added at 47:27 in Audio 1
§
In order to take care of dual mande
Using okun's law -- incorporate output gap □
Better prescrition is the taylor rule
FFR should be 1_% +1.5pit + o.5(output gap)
To capture max employment component
◊
®
Does much better because it includes employment
mandate
®
□
§
○
Slide 18
Bookmark added at 48:34 in Audio 1
§
Max emp is described as bringing econ back to potential
§
Price stability -- bringing inf rate back to 2%
§
○
Slide 19
Bookmark added at 48:58 in Audio 1
§
Stance of MP since 2000 -- fed contributed to great recession
Put some of the guilt on the fed -- they cfreated great
recession
□
§
Where do we stand now?
Black line is FFR
FFR put down FFR to 0 -- at 0 until 2006
®
Increasing it bit by bit since
®
Dashed blue line Is inflation target rule , red line is
OG taylor rule
®
Dotted red line is brand new/more sophisticated
taylor rule
®
You can look at great recession as
Blame fed for great recession
◊
Fed is not the only one responsible
◊
In 201 US had a recession in order to face
recession and help economy fed deided to
bring down FFR
Brought down FFR to 1-2% and left it
there for a while
}
The fed brought down FFR to a level
lower than prescribed by tyalor rule and
kept it too low for too long relative to
what is prescribed by taylor rule
This meant that if u think taylor
rule is truly prescription of ifhw
much medicine u should give a
patient fed gave too much
mediciene led patient to have
excess
Ended up being patient
household borrowed too
much money to buy houses
too big for their means
w
Fed maintained FFR for too
low for too long
w
Govt didn’t pay sufficient
attn to type of securities ---
many years of guilt
w
–
}
◊
®
□
Fed kept rate too low for too long
Ppl borwoed too much relative to how much they
were able to borrow
®
When fed realized they were able to increase rate
ppl felt squeezed realize they couldn’t afford their
big houses began to default --> recession
®
2008 taylore rule told fed to bring down int rute
because econ was going down super fast
Said to bring it down to -2 to -3 percent
No one wants to lend at negative rates it
means u are giving money to ppl
borrowing from u
If u wanna take a mortgage u
borrow 600K and bank will pay u to
borrow money to buy a house
–
Banks would rather sit on cash and
giving extra cash as pl take more
out of it
–
As an ind u would rather put it
under your matteress than leding it
at negative rate to a frend
–
Fed only cut rate to 0 although
taylor rule prescribed it to be way
below 0
–
This is where QE came in
Bookmark added at 54:06 in
Audio 1
w
–
}
◊
®
Going negative means not only central banks went
negative but also on customer
If u want to keep money in acct pay fee in
order to keep your cash --giving 1000 -- paying
50k
◊
Rather keep it under your mattress
◊
Why can we cahrge negative rates bc if u only
have 1000 you cant put it under your mattress
if ur a big corp you need to find big vaults held
by comm banks and central banks
They will chrage u
}
Derive int rates below o (for us -.5-.75)
Back then we thought this was
impossible
0 Lower bound
w
Now we know we can go
below 0
w
We call this effective lower
bound
w
–
}
◊
®
□
§
○
•
Slide 20
Bookmark added at 57:38 in Audio 1
Fed decided to explore unconventional monetary policy
§
Explored 2 things:
Forward guidance
Tells policy what u will do in the future
®
□
Quantitive easing (QE) -- putting your action where ur
mouth is
Action -- telling ppl it would be low for a long time --
if u don’t believe me I'll go in the market buy LT
securities
®
□
§
Forward guidance told ppl they would keep FFR low for a long
time
§
○
Hosl og unvonbrnyionsl polivy id yo ftibr foen lohnrt yrtm iny tsyrd snf
boody rvon htoeyh
○
qFFR is rate banks loan to eachother but this isnt hat we care about as
individuals we care about LT int rate
Usually by drivngi down int rates you drive down long term yield,
drive down expectations from commercial banking
§
Take action go into market -- drive down myself
Don’t mess w the fed□
§
○
•
Slide 21
Bookmark added at 01:00:03 in Audio 1
○
Forward guidance achieve its effect by inf market expectation for
future path of int rate
○
Fed was telling us they wont raise int rate anytime soon nowadays its
differtn j powell is telling ppl we will increase int rate -- get ready,
giving you a heads up THIS IS FORWARD GUIDANCE
○
•
Slide 22
Bookmark added at 01:00:55 in Audio 1
○
Forward guidance achieved by dot plots
○
Telling public -- this is where is ee rates
This is what im likely to do if nothing to change
§
○
Something telling:
Long run is nom int rate that FOMC sees as being consistent w
being consistent w keep econ At potential in the lR
If inf is 2% at LR this implies that the real rate is 1% (nom
rate is 3%)
Real rate includes C gorwth and I growth
®
□
They see potential output as being closer to 1% □
§
○
Giving pop -- remarkable we're achieving output growth
○
QE quantitaive Easing (QE) -- large-scale asset purchase (LSAP) program
Fed is trying to have impact on longer term int rates -- simply go
and purchase mortgage backed securities of longer securities
Driving up price of securities and yield□
Since yield on LT securities, yield on car loans and
mortgages will aslo go down
□
Stimulate consumption of cars, housing --> BOOSTING
ECON
□
Goal of QE same as bringing down FFR
Instead of only bringing down ST rate, you directly go
in market shaping yield curve myself by driving down
LT int rate for what household and firms really care
about
®
Buying big ticket items is not short term
®
□
§
○
Slide 24
Before QW fe dassets were maily in treasure securities
§
Bookmark added at 01:05:11 in Audio 1
§
Everything was based on who has mortgage backed securities
§
To remove risks fed used QE1 --
Green area- mortgage backed securities□
QE1-- takign toxic assets out of system □
§
No one knows who has bad mortgage backed secruiteis
§
Take mortagage backed securities --
2k11/2k12 econ is still not doing well□
§
Fed does QE2, QE3
Not meant to remove financial assets from system but to
reshape interest curve
□
Fed simply purchased 10 and 20 year treasury securities□
§
Bank ended up taking money in putting it back in fed at reserve
Fed basically said u give me mortage backed securities im
giving u acsh
□
You don’t trust him youre putting it back w me I give u int
rate on reserve
□
§
Green bar -- amt of $ comm banking system owned coming from
transaction of securities backed at fed
Also good for banking system bc u still may not trust your
neigh -- he bought mortgage backed securiteis but now he
is loaded w cash sitting in feds vault
□
Action recanonized banking center and bought more
security
□
§
If ppl can pay - return on assets is good
Rebuild trust -- by rebuilding trust u rebuild trust in econ it
does better ppl pay mortgage fed cashes in a bunch of cash
and everythign goes to treasury
□
§
○
Slide 26
Bookmark added at 01:12:48 in Audio 1
§
Blue line Is yield curve before QE 2 and 3
§
Longer term int rate at 2-3%
§
Yield curve after QE 2 and 3
§
Purchase of secruiteis led to substantial ___ in int rate
§
○
•
Slide 27
Bookmark added at 01:13:52 in Audio 1
Ppl were more afraid that an increase in MS through QW would lead to
massive increase in inflation
This never happened bc money never went out into econ -- just
comm banks sitting on cash at the fed
§
○
Bernanke was agenuius bc in 2008 he introduced interest rate on
reserve
He said u can park cash at the fed and I'll give u int rate on
reserve as opposed to before you did not get anything
§
Flash forwar to beginning of great recession you have comm
banks sitting on cash
They could take cash lend it out and generate inflation □
NOW instead of generating FFR you also move int rate on
reserve
□
If I don’t want u to take cash out and put it into econ I'll tell
u I'll give u bigger incentive to put it out on reserve
□
§
○
Excessive risk taking in fin market
Real concern
§
Banks are siting on aunch of ash willing to take more risk than
they would otherwise
§
Leads to overvalued stock market which is what we're
experiencing rn
§
○
•
READ LAST 2 SLIDES•
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LECTURE 15 -MONETARY POLICE
Monday, March 26, 2018
10:32 AM
Audio 1
Audio recording started: 10:32 AM Monday, March 26, 2018
Weekly News Update
J powell update
Below 2% target --- trying to reach target
§
Median projection for unemployment rate is 3.8% 3.6% over next
2 yrs
§
Inflation projection
§
Increase in FFR will help us reach this goal of meeting
unemployment target
§
Changing target for FFR is praimary means of achieving this
§
○
Headline inflation -- price of goods and services
Core excludes volatile prices of energy and produce
§
In the long run they should be the same but headline is much
more volatile because prices of energy and produce are
determined geopolitcally or things that completely outside of
supply and demand component,natural disasters, can fluctuate
quite a bit --- just about volatility
§
○
○
Increasing FFR will slow down output as long as fFR is below target
target value-- still boosting econ above what it is
Using real int rate there is one that corresponds to potential
output
§
Fed is increasing this rate but is stil below potential output but
increasing it on the rate its going up
§
Bookmark added at 12:16 in Audio 1
§
Increase in int rate leads to higher borrowing costs (slow down in
econ) this has an impact on AD output and inflation
Econ is reaching potential, we can still be accommodative
this is why we increase int rate
□
§
Nom int rate that corresponds to neutral rate is 3% we are at 1.5
§
○
If you increase the int rate then u slow down C I AD whenever AD firms
find it hard to sell product, they slack prices this decreases inf but we
want to INCREASE it so we want to have int rate lower than what it
would be at potentila
Still increasing rate bc were still below what it will be at at
potential
§
Right now nominal FFR that corresponds to econ at potential is
3% but we are rn at 1.5-1.75 (sitlll below) MP is still
accomodative/we're still boosting econ were just boosting it less
thatn we were last because
Raised to 1.5 so there's less money in the market --- to slow
it down
We're still lower because of 2008
®
We don't want to jump back up to 3 because it will
crash the market
®
□
§
○
If we raise rate over and above potential we're throwing economy
below potential output
If consumption and investment are below potential output, firms
slack prices in order to bring back market share
Inflation will go back down
□
§
All in terms of where potential would be its imporaant for fed to
understand potentila
§
○
Slide 3
US will apply tarrifs to chines imports
§
Bookmark added at 18:35 in Audio 1
§
What would happen if the US imposed tariffs on capital goods
§
○
Slide 6
Bookmark added at 24:48 in Audio 1
§
CAME FROM AN EXAM
§
Bookmark added at 28:29 in Audio 1
PART B
®
□
Bookmark added at 30:56 in Audio 1
NBR = 5
®
Borrowed reserves = 7
®
Borrow =2
®
□
Bookmark added at 33:09 in Audio 1□
§
○
Slide 13
Bookmark added at 35:35 in Audio 1
§
Go back to fisher EQ
§
How aggressive fed is at doing this is captured by the term m
§
The fed controls the nominal int rate but not the real int rate
Need to modify EQ using fisher EQ □
Fisher EQ used to transform real int rate to nominal int rate□
Nominal int rate = real + inflatoin should be equal to mb -
pit-pibar +r bar +pit
Calculate mbar pi bar r bar
®
Pi bar = central bank inf target of 2%
®
R bar = real int rate prevailing at potential = 2% ish
Linked to consumption grwoth rate and output
growth rate
◊
®
M bar = 1/2 h
®
If inf goes up by
Bookmark added at 39:01 in Audio 1
◊
Nom should go up by more than increase in
inflation bc of m and
◊
We set m to get a factor of inf rate greater
than 1
If # was 1 this would dsay that if inf rate
goes up by 1% nom int rate should go up
by 1%
}
Real int rate is 0 and youre not
controlling econ because real int rate
doesn’t change
}
In order to have impact on real int rate,
move econ, have impact on target u ned
m bar that will lead to oeff greater than 1
on inflation variable
}
If inflation goes up above 2% u need to
slow down econ
Ultimately u rslowing it down w
real int rate but tool is nom int rate
–
}
Effectively raisin gecon by 5%
Effect on C I AD and ifnlation
–
}
◊
®
□
§
○
Slide 14
Bookmark added at 41:27 in Audio 1
§
If inflation wer to rise by 1% policy response would be to raise
nom int rate by 1.5%
§
Real int rate should be raised to cool down econ when inf
increases, requiring the nominal int rate to increase more than
inf does
§
If ed were to inc int rate by less than 1% they would
accommodate inf increase which would lead to further increase
in inflation
If # was .5 (before pit)
U stimulate econ even more leading to more inflation
To fight inflatino you need to raise real rate
◊
Respond by increase in real int rate by more
than increase in inflation
◊
®
□
§
○
Slide 15
Bookmark added at 46:51 in Audio 1
§
If you plot crossed w MP rule
This graph shows how close you are to actual FFR□
§
○
Slide 16
Fed is only ajor central bank w dual mandate
§
Bookmark added at 47:27 in Audio 1
§
In order to take care of dual mande
Using okun's law -- incorporate output gap □
Better prescrition is the taylor rule
FFR should be 1_% +1.5pit + o.5(output gap)
To capture max employment component
◊
®
Does much better because it includes employment
mandate
®
□
§
○
Slide 18
Bookmark added at 48:34 in Audio 1
§
Max emp is described as bringing econ back to potential
§
Price stability -- bringing inf rate back to 2%
§
○
Slide 19
Bookmark added at 48:58 in Audio 1
§
Stance of MP since 2000 -- fed contributed to great recession
Put some of the guilt on the fed -- they cfreated great
recession
□
§
Where do we stand now?
Black line is FFR
FFR put down FFR to 0 -- at 0 until 2006
®
Increasing it bit by bit since
®
Dashed blue line Is inflation target rule , red line is
OG taylor rule
®
Dotted red line is brand new/more sophisticated
taylor rule
®
You can look at great recession as
Blame fed for great recession
◊
Fed is not the only one responsible
◊
In 201 US had a recession in order to face
recession and help economy fed deided to
bring down FFR
Brought down FFR to 1-2% and left it
there for a while
}
The fed brought down FFR to a level
lower than prescribed by tyalor rule and
kept it too low for too long relative to
what is prescribed by taylor rule
This meant that if u think taylor
rule is truly prescription of ifhw
much medicine u should give a
patient fed gave too much
mediciene led patient to have
excess
Ended up being patient
household borrowed too
much money to buy houses
too big for their means
w
Fed maintained FFR for too
low for too long
w
Govt didn’t pay sufficient
attn to type of securities ---
many years of guilt
w
–
}
◊
®
□
Fed kept rate too low for too long
Ppl borwoed too much relative to how much they
were able to borrow
®
When fed realized they were able to increase rate
ppl felt squeezed realize they couldn’t afford their
big houses began to default --> recession
®
2008 taylore rule told fed to bring down int rute
because econ was going down super fast
Said to bring it down to -2 to -3 percent
No one wants to lend at negative rates it
means u are giving money to ppl
borrowing from u
If u wanna take a mortgage u
borrow 600K and bank will pay u to
borrow money to buy a house
–
Banks would rather sit on cash and
giving extra cash as pl take more
out of it
–
As an ind u would rather put it
under your matteress than leding it
at negative rate to a frend
–
Fed only cut rate to 0 although
taylor rule prescribed it to be way
below 0
–
This is where QE came in
Bookmark added at 54:06 in
Audio 1
w
–
}
◊
®
Going negative means not only central banks went
negative but also on customer
If u want to keep money in acct pay fee in
order to keep your cash --giving 1000 -- paying
50k
◊
Rather keep it under your mattress
◊
Why can we cahrge negative rates bc if u only
have 1000 you cant put it under your mattress
if ur a big corp you need to find big vaults held
by comm banks and central banks
They will chrage u
}
Derive int rates below o (for us -.5-.75)
Back then we thought this was
impossible
0 Lower bound
w
Now we know we can go
below 0
w
We call this effective lower
bound
w
–
}
◊
®
□
§
○
•
Slide 20
Bookmark added at 57:38 in Audio 1
Fed decided to explore unconventional monetary policy
§
Explored 2 things:
Forward guidance
Tells policy what u will do in the future
®
□
Quantitive easing (QE) -- putting your action where ur
mouth is
Action -- telling ppl it would be low for a long time --
if u don’t believe me I'll go in the market buy LT
securities
®
□
§
Forward guidance told ppl they would keep FFR low for a long
time
§
○
Hosl og unvonbrnyionsl polivy id yo ftibr foen lohnrt yrtm iny tsyrd snf
boody rvon htoeyh
○
qFFR is rate banks loan to eachother but this isnt hat we care about as
individuals we care about LT int rate
Usually by drivngi down int rates you drive down long term yield,
drive down expectations from commercial banking
§
Take action go into market -- drive down myself
Don’t mess w the fed□
§
○
•
Slide 21
Bookmark added at 01:00:03 in Audio 1
○
Forward guidance achieve its effect by inf market expectation for
future path of int rate
○
Fed was telling us they wont raise int rate anytime soon nowadays its
differtn j powell is telling ppl we will increase int rate -- get ready,
giving you a heads up THIS IS FORWARD GUIDANCE
○
•
Slide 22
Bookmark added at 01:00:55 in Audio 1
○
Forward guidance achieved by dot plots
○
Telling public -- this is where is ee rates
This is what im likely to do if nothing to change
§
○
Something telling:
Long run is nom int rate that FOMC sees as being consistent w
being consistent w keep econ At potential in the lR
If inf is 2% at LR this implies that the real rate is 1% (nom
rate is 3%)
Real rate includes C gorwth and I growth
®
□
They see potential output as being closer to 1% □
§
○
Giving pop -- remarkable we're achieving output growth
○
QE quantitaive Easing (QE) -- large-scale asset purchase (LSAP) program
Fed is trying to have impact on longer term int rates -- simply go
and purchase mortgage backed securities of longer securities
Driving up price of securities and yield□
Since yield on LT securities, yield on car loans and
mortgages will aslo go down
□
Stimulate consumption of cars, housing --> BOOSTING
ECON
□
Goal of QE same as bringing down FFR
Instead of only bringing down ST rate, you directly go
in market shaping yield curve myself by driving down
LT int rate for what household and firms really care
about
®
Buying big ticket items is not short term
®
□
§
○
Slide 24
Before QW fe dassets were maily in treasure securities
§
Bookmark added at 01:05:11 in Audio 1
§
Everything was based on who has mortgage backed securities
§
To remove risks fed used QE1 --
Green area- mortgage backed securities□
QE1-- takign toxic assets out of system □
§
No one knows who has bad mortgage backed secruiteis
§
Take mortagage backed securities --
2k11/2k12 econ is still not doing well□
§
Fed does QE2, QE3
Not meant to remove financial assets from system but to
reshape interest curve
□
Fed simply purchased 10 and 20 year treasury securities□
§
Bank ended up taking money in putting it back in fed at reserve
Fed basically said u give me mortage backed securities im
giving u acsh
□
You don’t trust him youre putting it back w me I give u int
rate on reserve
□
§
Green bar -- amt of $ comm banking system owned coming from
transaction of securities backed at fed
Also good for banking system bc u still may not trust your
neigh -- he bought mortgage backed securiteis but now he
is loaded w cash sitting in feds vault
□
Action recanonized banking center and bought more
security
□
§
If ppl can pay - return on assets is good
Rebuild trust -- by rebuilding trust u rebuild trust in econ it
does better ppl pay mortgage fed cashes in a bunch of cash
and everythign goes to treasury
□
§
○
Slide 26
Bookmark added at 01:12:48 in Audio 1
§
Blue line Is yield curve before QE 2 and 3
§
Longer term int rate at 2-3%
§
Yield curve after QE 2 and 3
§
Purchase of secruiteis led to substantial ___ in int rate
§
○
•
Slide 27
Bookmark added at 01:13:52 in Audio 1
Ppl were more afraid that an increase in MS through QW would lead to
massive increase in inflation
This never happened bc money never went out into econ -- just
comm banks sitting on cash at the fed
§
○
Bernanke was agenuius bc in 2008 he introduced interest rate on
reserve
He said u can park cash at the fed and I'll give u int rate on
reserve as opposed to before you did not get anything
§
Flash forwar to beginning of great recession you have comm
banks sitting on cash
They could take cash lend it out and generate inflation □
NOW instead of generating FFR you also move int rate on
reserve
□
If I don’t want u to take cash out and put it into econ I'll tell
u I'll give u bigger incentive to put it out on reserve
□
§
○
Excessive risk taking in fin market
Real concern
§
Banks are siting on aunch of ash willing to take more risk than
they would otherwise
§
Leads to overvalued stock market which is what we're
experiencing rn
§
○
•
READ LAST 2 SLIDES•
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LECTURE 15 -MONETARY POLICE
Monday, March 26, 2018 10:32 AM
Audio 1
Audio recording started: 10:32 AM Monday, March 26, 2018
Weekly News Update
J powell update
Below 2% target --- trying to reach target
§
Median projection for unemployment rate is 3.8% 3.6% over next
2 yrs
§
Inflation projection
§
Increase in FFR will help us reach this goal of meeting
unemployment target
§
Changing target for FFR is praimary means of achieving this
§
○
Headline inflation -- price of goods and services
Core excludes volatile prices of energy and produce
§
In the long run they should be the same but headline is much
more volatile because prices of energy and produce are
determined geopolitcally or things that completely outside of
supply and demand component,natural disasters, can fluctuate
quite a bit --- just about volatility
§
○
○
Increasing FFR will slow down output as long as fFR is below target
target value-- still boosting econ above what it is
Using real int rate there is one that corresponds to potential
output
§
Fed is increasing this rate but is stil below potential output but
increasing it on the rate its going up
§
Bookmark added at 12:16 in Audio 1
§
Increase in int rate leads to higher borrowing costs (slow down in
econ) this has an impact on AD output and inflation
Econ is reaching potential, we can still be accommodative
this is why we increase int rate
□
§
Nom int rate that corresponds to neutral rate is 3% we are at 1.5
§
○
If you increase the int rate then u slow down C I AD whenever AD firms
find it hard to sell product, they slack prices this decreases inf but we
want to INCREASE it so we want to have int rate lower than what it
would be at potentila
Still increasing rate bc were still below what it will be at at
potential
§
Right now nominal FFR that corresponds to econ at potential is
3% but we are rn at 1.5-1.75 (sitlll below) MP is still
accomodative/we're still boosting econ were just boosting it less
thatn we were last because
Raised to 1.5 so there's less money in the market --- to slow
it down
We're still lower because of 2008
®
We don't want to jump back up to 3 because it will
crash the market
®
□
§
○
If we raise rate over and above potential we're throwing economy
below potential output
If consumption and investment are below potential output, firms
slack prices in order to bring back market share
Inflation will go back down □
§
All in terms of where potential would be its imporaant for fed to
understand potentila
§
○
Slide 3
US will apply tarrifs to chines imports
§
Bookmark added at 18:35 in Audio 1
§
What would happen if the US imposed tariffs on capital goods
§
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Slide 6
Bookmark added at 24:48 in Audio 1
§
CAME FROM AN EXAM
§
Bookmark added at 28:29 in Audio 1
PART B
®
□
Bookmark added at 30:56 in Audio 1
NBR = 5
®
Borrowed reserves = 7
®
Borrow =2
®
□
Bookmark added at 33:09 in Audio 1
□
§
○
Slide 13
Bookmark added at 35:35 in Audio 1
§
Go back to fisher EQ
§
How aggressive fed is at doing this is captured by the term m
§
The fed controls the nominal int rate but not the real int rate
Need to modify EQ using fisher EQ
□
Fisher EQ used to transform real int rate to nominal int rate
□
Nominal int rate = real + inflatoin should be equal to mb -
pit-pibar +r bar +pit
Calculate mbar pi bar r bar
®
Pi bar = central bank inf target of 2%
®
R bar = real int rate prevailing at potential = 2% ish
Linked to consumption grwoth rate and output
growth rate
◊
®
M bar = 1/2 h
®
If inf goes up by
Bookmark added at 39:01 in Audio 1
◊
Nom should go up by more than increase in
inflation bc of m and
◊
We set m to get a factor of inf rate greater
than 1
If # was 1 this would dsay that if inf rate
goes up by 1% nom int rate should go up
by 1%
}
Real int rate is 0 and youre not
controlling econ because real int rate
doesn’t change
}
In order to have impact on real int rate,
move econ, have impact on target u ned
m bar that will lead to oeff greater than 1
on inflation variable
}
If inflation goes up above 2% u need to
slow down econ
Ultimately u rslowing it down w
real int rate but tool is nom int rate
–
}
Effectively raisin gecon by 5%
Effect on C I AD and ifnlation
–
}
◊
®
□
§
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Slide 14
Bookmark added at 41:27 in Audio 1
§
If inflation wer to rise by 1% policy response would be to raise
nom int rate by 1.5%
§
Real int rate should be raised to cool down econ when inf
increases, requiring the nominal int rate to increase more than
inf does
§
If ed were to inc int rate by less than 1% they would
accommodate inf increase which would lead to further increase
in inflation
If # was .5 (before pit)
U stimulate econ even more leading to more inflation
To fight inflatino you need to raise real rate
◊
Respond by increase in real int rate by more
than increase in inflation
◊
®
□
§
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Slide 15
Bookmark added at 46:51 in Audio 1
§
If you plot crossed w MP rule
This graph shows how close you are to actual FFR□
§
○
Slide 16
Fed is only ajor central bank w dual mandate
§
Bookmark added at 47:27 in Audio 1
§
In order to take care of dual mande
Using okun's law -- incorporate output gap □
Better prescrition is the taylor rule
FFR should be 1_% +1.5pit + o.5(output gap)
To capture max employment component
◊
®
Does much better because it includes employment
mandate
®
□
§
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Slide 18
Bookmark added at 48:34 in Audio 1
§
Max emp is described as bringing econ back to potential
§
Price stability -- bringing inf rate back to 2%
§
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Slide 19
Bookmark added at 48:58 in Audio 1
§
Stance of MP since 2000 -- fed contributed to great recession
Put some of the guilt on the fed -- they cfreated great
recession
□
§
Where do we stand now?
Black line is FFR
FFR put down FFR to 0 -- at 0 until 2006
®
Increasing it bit by bit since
®
Dashed blue line Is inflation target rule , red line is
OG taylor rule
®
Dotted red line is brand new/more sophisticated
taylor rule
®
You can look at great recession as
Blame fed for great recession
◊
Fed is not the only one responsible
◊
In 201 US had a recession in order to face
recession and help economy fed deided to
bring down FFR
Brought down FFR to 1-2% and left it
there for a while
}
The fed brought down FFR to a level
lower than prescribed by tyalor rule and
kept it too low for too long relative to
what is prescribed by taylor rule
This meant that if u think taylor
rule is truly prescription of ifhw
much medicine u should give a
patient fed gave too much
mediciene led patient to have
excess
Ended up being patient
household borrowed too
much money to buy houses
too big for their means
w
Fed maintained FFR for too
low for too long
w
Govt didn’t pay sufficient
attn to type of securities ---
many years of guilt
w
–
}
◊
®
□
Fed kept rate too low for too long
Ppl borwoed too much relative to how much they
were able to borrow
®
When fed realized they were able to increase rate
ppl felt squeezed realize they couldn’t afford their
big houses began to default --> recession
®
2008 taylore rule told fed to bring down int rute
because econ was going down super fast
Said to bring it down to -2 to -3 percent
No one wants to lend at negative rates it
means u are giving money to ppl
borrowing from u
If u wanna take a mortgage u
borrow 600K and bank will pay u to
borrow money to buy a house
–
Banks would rather sit on cash and
giving extra cash as pl take more
out of it
–
As an ind u would rather put it
under your matteress than leding it
at negative rate to a frend
–
Fed only cut rate to 0 although
taylor rule prescribed it to be way
below 0
–
This is where QE came in
Bookmark added at 54:06 in
Audio 1
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–
}
◊
®
Going negative means not only central banks went
negative but also on customer
If u want to keep money in acct pay fee in
order to keep your cash --giving 1000 -- paying
50k
◊
Rather keep it under your mattress
◊
Why can we cahrge negative rates bc if u only
have 1000 you cant put it under your mattress
if ur a big corp you need to find big vaults held
by comm banks and central banks
They will chrage u
}
Derive int rates below o (for us -.5-.75)
Back then we thought this was
impossible
0 Lower bound
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Now we know we can go
below 0
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We call this effective lower
bound
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–
}
◊
®
□
§
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•
Slide 20
Bookmark added at 57:38 in Audio 1
Fed decided to explore unconventional monetary policy
§
Explored 2 things:
Forward guidance
Tells policy what u will do in the future
®
□
Quantitive easing (QE) -- putting your action where ur
mouth is
Action -- telling ppl it would be low for a long time --
if u don’t believe me I'll go in the market buy LT
securities
®
□
§
Forward guidance told ppl they would keep FFR low for a long
time
§
○
Hosl og unvonbrnyionsl polivy id yo ftibr foen lohnrt yrtm iny tsyrd snf
boody rvon htoeyh
○
qFFR is rate banks loan to eachother but this isnt hat we care about as
individuals we care about LT int rate
Usually by drivngi down int rates you drive down long term yield,
drive down expectations from commercial banking
§
Take action go into market -- drive down myself
Don’t mess w the fed□
§
○
•
Slide 21
Bookmark added at 01:00:03 in Audio 1
○
Forward guidance achieve its effect by inf market expectation for
future path of int rate
○
Fed was telling us they wont raise int rate anytime soon nowadays its
differtn j powell is telling ppl we will increase int rate -- get ready,
giving you a heads up THIS IS FORWARD GUIDANCE
○
•
Slide 22
Bookmark added at 01:00:55 in Audio 1
○
Forward guidance achieved by dot plots
○
Telling public -- this is where is ee rates
This is what im likely to do if nothing to change
§
○
Something telling:
Long run is nom int rate that FOMC sees as being consistent w
being consistent w keep econ At potential in the lR
If inf is 2% at LR this implies that the real rate is 1% (nom
rate is 3%)
Real rate includes C gorwth and I growth
®
□
They see potential output as being closer to 1% □
§
○
Giving pop -- remarkable we're achieving output growth
○
QE quantitaive Easing (QE) -- large-scale asset purchase (LSAP) program
Fed is trying to have impact on longer term int rates -- simply go
and purchase mortgage backed securities of longer securities
Driving up price of securities and yield□
Since yield on LT securities, yield on car loans and
mortgages will aslo go down
□
Stimulate consumption of cars, housing --> BOOSTING
ECON
□
Goal of QE same as bringing down FFR
Instead of only bringing down ST rate, you directly go
in market shaping yield curve myself by driving down
LT int rate for what household and firms really care
about
®
Buying big ticket items is not short term
®
□
§
○
Slide 24
Before QW fe dassets were maily in treasure securities
§
Bookmark added at 01:05:11 in Audio 1
§
Everything was based on who has mortgage backed securities
§
To remove risks fed used QE1 --
Green area- mortgage backed securities□
QE1-- takign toxic assets out of system □
§
No one knows who has bad mortgage backed secruiteis
§
Take mortagage backed securities --
2k11/2k12 econ is still not doing well□
§
Fed does QE2, QE3
Not meant to remove financial assets from system but to
reshape interest curve
□
Fed simply purchased 10 and 20 year treasury securities□
§
Bank ended up taking money in putting it back in fed at reserve
Fed basically said u give me mortage backed securities im
giving u acsh
□
You don’t trust him youre putting it back w me I give u int
rate on reserve
□
§
Green bar -- amt of $ comm banking system owned coming from
transaction of securities backed at fed
Also good for banking system bc u still may not trust your
neigh -- he bought mortgage backed securiteis but now he
is loaded w cash sitting in feds vault
□
Action recanonized banking center and bought more
security
□
§
If ppl can pay - return on assets is good
Rebuild trust -- by rebuilding trust u rebuild trust in econ it
does better ppl pay mortgage fed cashes in a bunch of cash
and everythign goes to treasury
□
§
○
Slide 26
Bookmark added at 01:12:48 in Audio 1
§
Blue line Is yield curve before QE 2 and 3
§
Longer term int rate at 2-3%
§
Yield curve after QE 2 and 3
§
Purchase of secruiteis led to substantial ___ in int rate
§
○
•
Slide 27
Bookmark added at 01:13:52 in Audio 1
Ppl were more afraid that an increase in MS through QW would lead to
massive increase in inflation
This never happened bc money never went out into econ -- just
comm banks sitting on cash at the fed
§
○
Bernanke was agenuius bc in 2008 he introduced interest rate on
reserve
He said u can park cash at the fed and I'll give u int rate on
reserve as opposed to before you did not get anything
§
Flash forwar to beginning of great recession you have comm
banks sitting on cash
They could take cash lend it out and generate inflation □
NOW instead of generating FFR you also move int rate on
reserve
□
If I don’t want u to take cash out and put it into econ I'll tell
u I'll give u bigger incentive to put it out on reserve
□
§
○
Excessive risk taking in fin market
Real concern
§
Banks are siting on aunch of ash willing to take more risk than
they would otherwise
§
Leads to overvalued stock market which is what we're
experiencing rn
§
○
•
READ LAST 2 SLIDES•
w
w
w
w
w
LECTURE 15 -MONETARY POLICE
Monday, March 26, 2018 10:32 AM
Document Summary
Audio recording started: 10:32 am monday, march 26, 2018. Below 2% target --- trying to reach target. Median projection for unemployment rate is 3. 8% 3. 6% over next. Increase in ffr will help us reach this goal of meeting unemployment target. Changing target for ffr is praimary means of achieving this. Headline inflation -- price of goods and services. Core excludes volatile prices of energy and produce. Increasing ffr will slow down output as long as ffr is below target target value-- still boosting econ above what it is. Using real int rate there is one that corresponds to potential output. Fed is increasing this rate but is stil below potential output but increasing it on the rate its going up. Increase in int rate leads to higher borrowing costs (slow down in. Increase in int rate leads to higher borrowing costs (slow down in econ) this has an impact on ad output and inflation.
