The last three or four decades have seen a remarkable evolution in the institutions that comprise the modern monetary system. The financial crisis of 2007-2009 is a wakeup call that we need a similar evolution in the analytical apparatus and theories that we use to understand that system. Produced and sponsored by the Institute for New Economic Thinking, this course is an attempt to begin the process of new economic thinking by reviving and updating some forgotten traditions in monetary thought that have become newly relevant. Three features of the new system are central. Most important, the intertwining of previously separate capital markets and money markets has produced a system with new dynamics as well as new vulnerabilities. The financial crisis revealed those vulnerabilities for all to see. The result was two years of desperate innovation by central banking authorities as they tried first this, and then that, in an effort to stem the collapse. Second, the global character of the crisis has revealed the global character of the system, which is something new in postwar history but not at all new from a longer time perspective. Central bank cooperation was key to stemming the collapse, and the details of that cooperation hint at the outlines of an emerging new international monetary order. Third, absolutely central to the crisis was the operation of key derivative contracts, most importantly credit default swaps and foreign exchange swaps. Modern money cannot be understood separately from modern finance, nor can modern monetary theory be constructed separately from modern financial theory. That's the reason this course places dealers, in both capital markets and money markets, at the very center of the picture, as profit-seeking suppliers of market liquidity to the new system of market-based credit.
Central Bank Operations, Normal Times
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Do curso por Columbia University
Economics of Money and Banking
501 classificação
Na lição
Midterm review and exam
The first twelve lectures have introduced all of the main concepts of the course. The midterm exam gives you a chance to test whether you have mastered these concepts before extending them into new areas in the second part of the course. But before you try the exam, first use the review lecture, and the questions from students, to review the main concepts.
Conheça os instrutores
Perry G MehrlingProfessor
Economics, Barnard College
[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?
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