[COUGH] These, remember last time I started with these, these three these three pictures here. The fed funds market, the term interest, the term funding markets and the bond market here and talked about the transmission of monetary policy from one to the other, okay, that the fed. is, is sitting on top of the hierarchy of money and credit up here. Okay. And, in, and, and that, that, that, that hierarchy, is fluctuating over time. Okay? So that you're moving to a boom and a crash here and moving back and forth between these. And what the fed is trying to do, because it's taken on responsibility for supporting the system if there really is a crash, it tries to control these fluctuations. Okay, to keep the boom from being quite so boomy and to keep the crash from being quite so crashy, okay? And it does this by manipulating the by manipulating the money supply, you could say, or in this class we focus much more on the money rate of interest, okay? So there's the story here that if you think um,that you want to, if we're, too much elasticity is the problem [SOUND] Okay, that is to say, too boomy. Okay, too much credit. Okay, too much expansion. the fed can try to make settlement harder, okay? Make it more, more painful, more expensive to put settlement of till tomorrow, okay? And not do it today. By making it more expensive, that's just by raising the Fed funds rate. Okay, say you raise the Fed funds rate, then that's the cost of putting settlement off 'til tomorrow. Okay? So, the Fed can respond. The Fed can raise the Fed funds rate. Okay, I'll call that rFF for Fed Funds Rate. Raise the Fed Funds Rate. Okay, and that has consquences for the dealers that are making funding markets. Okay that they raise the term. Interest rate. Okay, that's the rate that dealers pay who are funding their inventories of bonds, and so, that makes it more expensive for them to hold inventory, so they don't want to hold so much inventories, and they try to get rid of them by making bonds cheaper. Okay. So there's this transmission mechanism from the overnight interest rate to the term interest rate to the, to asset prices here. Okay? the, this is the, what the fed does. This is the consequence of, of dealer activity. And this is the consequence of dealer activity. The Fed is not setting these prices, these are responses. Because the, this dealer is experiencing that when the Fed funds rate goes up, his spread, the spread between the term rate and the Fed funds rate, shrinks. So the profitability of his business shrinks. And so, he says, I'm not going to do that much more business, or I'm only willing to expand my balance sheet more if I get a better rate, if I get a better term rate here, so that's the transmission mechanism, and similarly, and similarly here okay these, these effects at the short end get transmitted. Now, what is the con, the consequence of that may or may not be contraction of credit. Okay. Contraction of credit? Okay. Certainly if the fed raises the short term rate enough, okay, it can get some leverage on this system. Okay. And it can cause contraction here, it can cause contraction here. But if it moves it a little bit, it may well be, in a boomy time, that people say well, look, its only another 50 basis points. Lets just raise it all 50 basis points and we're fine. Lets keep on going. Okay, so it's important to emphasize that the feds leverage over the system the things it wants to control, right? Its trying to control this, this, this expansion of credit. But by changing the price here it doesn't speci, doesn't necessarily translate immediately into a chan, into, into contraction of credit. and in a boom there's a lot, a lot of stuff in the pipeline and they can keep going for, for, for quite a while. The Fed knows this that's why they try to sort of get a jump on it ahead of time and anticipate in the future and things like that. Okay? Eventually maybe it will cause a contraction of credit. because the Fed can raise this rate to the moon, okay? And make it inverted and inverted an inverted yield curve and that is to say to make the dealer actions here unprofitable, not just very profitable but actively unprofitable, okay, and one thing dealers will do if you make life unprofitable, they will stop dealing. They're not in this you know, to help their customers, they're in this to make a profit. So, you can manipulate dealers by manipulating the profitability of dealing activity. That's whats going on here. So if the problem is too much elasticity, you can do this. If the problem is too much discipline? Okay? So if the system is, is crashing, okay, you can try the opposite, right? You can, you can reduce the Fed funds rate. Okay? And hope that, that transfers into a reduction of the term interest rate. Okay? And hope that transfers into an increase in the price of bonds. Through the same dealer, dealer profitability competition channels. Okay. This is the, the, the story about transmission from short rates to, to, to term rates, to bond prices, okay. The question is, will this lead to an expansion of credit? And the answer is again, not necessarily. Not necessarily. Somebody has to be demanding this credit and, and, and in order for that they have to have some anticipation that it's going to be profitable to do something new. And this is of course the situation we're in right now in the United States. Interest rates are basically zero, there's nowhere else to go, the Fed is pushing, you know, on a string, as Kaynes would say, you know, with this QE three now, it's embarked upon, trying to somehow get a vigorous expansion of credit under way, and it's not having a hell of a lot of luck. Okay with this. There's an asymmetry here. The Fed can always stop the economy in it's paces by getting the Fed funds rate high enough. Okay, it cannot always jump start the economy by getting the interest rate low enough. Okay, there's an asymmetry, and that asymmetry comes from the survival constraint, the settlement constraint. Right, which is asymmetric. The settlement constraint says right, you have to pay your bills as they come due. It does not say, you have to make promises about the future. You know? It doesn't say that at all. It just says that the promises you've made in the past, you have to settle with today. Okay? So it's, it's asymmetric, okay, it's the people who made promises who are on the hook. [SOUND] And you can make it dif, you can make it more difficult for them, okay, but just by making it easier for them, doesn't mean they'll make more promises. Okay? They may just deleverage. They may just keep paying back their debts and not making new ones. Okay? And that's what's going on okay? All over the world, okay?
