FNCE 101 Lecture Notes - Lecture 1: Jerome H. Powell, Nairu, Risk Premium
The deviation of real GDP from its potential level has long been
regarded as a standard measure of economic slack
When the economy grows faster than its potential, the effects
are widespread: Overtime hours increase for workers, capital
utilization rates go up for businesses, and inflation pressures
mount for consumers.
○
Output gap- diff btwn real GDP and its potential level
Closely scrutinized by policy makers
§
○
Data on real GDP come from the National Income and Product
Accounts (NIPA) published by the Bureau of Economic Analisys
○
Data on potential GDP are revised less frequently
Potential GDP had moved slowly enough that the CBO
releases yearly updates together w 10 yr projections
§
Potential GDP can change in times of economic tumult]
§
○
•
We measure inflation using the personal consumption expenditures
price index (PCEPI) excluding food and energy. This measure is
commonly referred to as core PCE inflation.
Although the Federal Reserve is ultimately interested in
ensuring that headline inflation remains stable, core inflation is
significantly less volatile and therefore offers a more reliable
measure
○
•
CLASS NOTES
•
Audio recording started: 10:34 AM Wednesday, March 28, 2018
Audio recording started: 10:34 AM Wednesday, March 28, 2018
Audio 3
Audio recording started: 10:35 AM Wednesday, March 28, 2018
Taylor Rule
We need a measure of econ slacks and a measure of inflation •
Slide 2
First measure of slack
○
Output gap
When econ grows faster than potential it becomes hard
for firms to meet demand and they have an incentive to
increase prices leading to further inflation
Overtime hrs increase□
Capital util rates increase□
Inflation pressures mount for consumers□
Increase in AD --> increase output gap --> increase
in inflation
□
§
○
•
Slide 3
Bookmark added at 02:03 in Audio 3
○
GDP recorded quarterly
Comes roughly a month after quarter ends
§
○
Not reported frequently
In past revisions didn’t really matter
§
Although we were revising every 3 yrs big
recessions/expansions didn’t change shape of economy
or output trajectory
§
However great recession changed everything/ output
trajectory
§
○
What impact do these revisions have on output gap?
GDP has been revised downward since 2007
§
Dotted line: real GDP
§
From current GDP we are still way below potential
If we had been on same economic trajectory 2007
line is where we should be but real gdp shows
where we actually are
□
We are hyper percent above potential output□
§
If were above potential we can bring up the int rate
§
Good estimate of GDP is key in studying monetary policy
§
○
•
Slide 5
We will use an updated version of the Taylor rule
○
It= 1.25+1.5xpit +1*output gap
○
Pi is core PCE inflation, measured each month
○
What is the current prescription for the federal funds rate?
When econ is at potential output gap is 0 and inflation is
at 2
§
So FFR/it is 4.25 -- this value is what keeps econ at
potential
§
○
We use core inflation bc headline inflation is highly volatile bc
of food and energy prices
○
What is the current prescription for the FFR?
We are above the output gap (+.5)
§
Below target for inflation
§
It = 1.25 +1.5*1.5+.5 =4 --- roughly what the taylor rule is
calling the fed to do
§
○
Vintages?
If u use current potentail weve been at potential since
2017 now we are above potential
§
This corresponds w inflation #
FFR below 0 200, 2012 --- around 0 2012-2014,
increase in FFR calling for 4% in 2017 Q4
□
Way above current FFR of 1.5-1.75%□
We are so far off potential that the taylor rule is
telling the fed to cut rate way below 0 to make
econ go back to potentail I
□
What Bookmark added at 14:18 in Audio 3□
P□
§
During great recession we lost a lot of the labor force --
some bc they were close to retirement age
Bringing ppl who have not been employed can be
hard bc they may not have the skills required to
succeed
□
Trajectory itself might not have changed -- (of graph
1) what has changed is really the level
Didn’t happen in other recessions -- much
milder
®
□
§
2007 didn’t know recession would be that bad -- why
taylor rule is calling for diff FFR
§
○
•
Slide 7
Bookmark added at 17:36 in Audio 3
Dual mandate of fed is max emp and price stablitiy
○
Theres a relationship btwn low unemp and max output
○
Try to modify taylor rule to sub output gap w unemployment
gap
○
LECTURE 7 --- LABOR MKT
Using Okun's law
§
○
Adv of using unemp gap
Much more direct measure of fed's dual mandate
§
Unemp data as opposed to GDP data evolve much more
timely
§
Since beginning of feb you know january unemp rate
§
You only have info on 2018 Q1 at beginnign fo april
§
Unemp #s are much more timely
Monthly not quarterly□
We use unemp gap -- ut= headline unemployment u
bar is natural rate or NAIRU -- unemp that keeps
econ on even keel
□
§
Okun's law ---
Output gap = -2* unemployment gap □
§
○
Do output gap and unemployment gap taylor rules always call
for similar rate
If okun's law is true it should but taylor rule output gap v
unemp gap there is a divergence that emerged since the
great recession
Most of the time they called for the same FFR □
Okuns law is a pretty good rule of thumb -- come
great recession we see a big divergence
□
Output taylor rule says sm different that
unemployment taylor rule
Instead of as a measure of output gap you see
that econ is doing much worse than it usually
does
®
Output gap perspective econ is doing pretty
badly but has recovered from 2011-2012
®
Unemployment gap perspective --- took a
number of years for econ to recover
Divergence btwn the 2 -- made it hard
for fed to figure out what to do
◊
Recessions are not all good to go
◊
Right measure to put in taylor rule?
2 measures of econ slack give
very different prescriptions as to
what FFR should be
}
If you use output gap perspective
its not as bad bc firms tried to use
as much capital as possible after
they fired ppl
}
◊
®
□
§
○
•
Slide 10
○
Bookmark added at 26:40 in Audio 3
○
Uncertainty about entering job market conditions
○
Ultimately policy makers need to make jugments about how
much conflicting indicators reflect cyclical weakness in job
market
○
Why did fed keep FFR so low for so long
Recession was severe
§
Depending on which measure of econ activity youre
looking at u get dif prescription
§
Fed tried to play it safe and keep FFR low for a long time
§
Dif measures of unemp told us dif things about the state
of the labor market
§
○
Traditionally whether u look at headline unemp
Bookmark added at 28:11 in Audio 3
Usually call for all kind of policy rate bc they all move in a
similar fashion
§
○
•
Slid 13
Before great recession
Red line is headline unemp □
They are dif but all move in a similar fashion □
Come great recession things are way different □
Discrepancies btwn measures is different□
Another measure of unemp that we call non-
employment
Everyone not in the labor force -- all fo the
people who have quit + all of the unemployed
®
This measure has always followed U3
®
Unemp comes back down nonemp stays flat
bc we lost a lot ofppl that jumped out of the
labor force and never came back
®
Short term unemp is a narrower measure
®
U4 u5 u6 are broader
®
Nonemplyment is even broader
®
□
§
Do these measures also call for diff policy rates? Using
taylor rule do alt measures of labor mkt slack all call for
same FFR?
Fed miht be able to fix cyclical □
But long term -- skills required might have
changed -- can be fixed w social policy
□
§
2007 was a long lasting recession - somewhat of a
depression
Hope to bring back some people □
Slide 16-- different taylor rule prescriptions
depending on dif measures of unemp
Fed feels confident about raising the rate
®
All equations tell us to raise the rate
®
Althoughwere at potential we don’t see it
picking up
®
Bookmark added at 38:16 in Audio 3
®
Were able to attract ppl from outside of labor
force to join
Also having impact on U6
Taking ppl unemp making them
eployed
}
Also ppl whow ere unemp and
putting them back in labor force
Fixing structural issues
–
Fixing the labor force as
much as possible
–
}
◊
®
□
§
Slide 14
Bookmark added at 39:55 in Audio 3
Decline in labor force participation rate
§
As discrimination policy broke down we see an increase
but since 2007 there is a decrease
Permanent shift? Yes
Aging of population
®
Milenialls don’t want to work as much as
their parents
®
Shift that has to do w mentality
®
Ppl in new generation don’t want to work
that much
New generation is notw illing to work
40 hrs
◊
®
□
§
○
Slide 17
Bookmark added at 43:18 in Audio 3
Which measure of unemp is best
§
Bookmark added at 47:36 in Audio 3
Which emesure of unemp is best?
None of them□
All say sm different□
Divergent so FOMC must make judgement about
what each message is sending
□
Decide what the conflicting signals refelct?
Cyclical weakness
®
Permanent structural factors
®
□
Relying on rule driven by single market indicator
has become more difficult
Recession was a change in mentality, culture,
demographics
®
Hard fo rfed to absorb everything
®
□
§
Might as well use U3
Bookmark added at 49:38 in Audio 3□
Now ere at a stage where it seems theyre coming
back to have same relationship they once had
As long as relationship is the same it
shouldn’t matter which u use (this is what
graph 5 shows -- slide 16) they all call for
same FFR
®
□
Ppl who arent in LF reflects a structural issue not
cyclcical
□
§
○
Slide 18
Bookmark added at 51:12 in Audio 3
§
A strong dollar elads americans to purchase goods and
services for cheap leading to lwoer inflation
§
A strong dollar also makes us good esxpensive for
foreigners they mightnt by as many leading to lower
exports, net exports, aggregate demand which leads to
lower ouput and inflation
§
State of us dollar relative to other currencies in the world
as well as stae of global econ also has impact on US econ
and monetary policy
§
How does current strength..
Bookmark added at 53:01 in Audio 3□
Yr ago global eocn wasn’t doing very well this year
it is doing well
□
Impact of synchronized global econ on US output
and inflation?
When rest of world does well they buy more
goods and services (and more US goods and
services) this drives up AD when rest of world
and US is doing well so price of global
commodities will go up so it increases
inflation
®
□
Trade tensions?
If you impose tariffs on a country like china
you buy less which will then decrease imports
®
Retailiation from china -- they buy less goods
and services
Negative impact on output
◊
®
Tariffs on chines goods makes it more
expensive
Supply shock (inc inflation, decreasing
output) … just like an oil price shock
◊
What does this imply for US monetary
policy and FFR
◊
®
□
§
○
Slide 19
If change sin monetary policy led to …
§
Bookmark added at 56:15 in Audio 3
§
Should fed be more aggressive in normalizing the FFR?
Risk of doing it too early? Risk of waiting too long?
Bookmark added at 56:44 in Audio 3□
Takes a yr or 2 for impact of monetary policy to
feed into econ
□
There is a downside of waiting too long or going to
early
□
Trend is important□
§
○
Slide 20
Bookmark added at 57:58 in Audio 3
§
Fed wabted ti reoakce FOMC w a computer
§
Why hasn’t the fed put the taylor rule on autopilot?
Is there more to monetary policy than this equation □
There are shocks -- withoutu someone there
looking at what is happening then you could end up
with something that isnt the right thing to do
□
§
○
Sldie 21
Bookmark added at 01:00:27 in Audio 3
§
What should jay powell do? --- look for this on final
§
○
•
CASTE STUDY #2
•
Bookmark added at 01:01:12 in Audio 3•
Yield curve is the yield of types of bonds of diff maturity•
Mkt for govt bonds
Yield curve is just the yield that the bond gives at diff maturities
○
Yield on 10yr treasury is about 10.9%
○
Yield on 3 month treasury is about 1.75%
○
Yield curve is simply telling u the yield for bonds that are
comparable at different maturities
○
The FFR is very similar to 3 3month treasury bc for a comm bank
u can either lend to the govt at 3 mo rate or go in FFMarket and
roll over cash at FFR for 6 weeks
In 6 weeks FOMC will meet again only gonna go up or
down by 10 poitns
§
Substitute for commercial banks in terms of lending
opportunities
§
○
•
Yield curve tells us that if as comm bank u can roll cash around for 3
mos?
Slope of yield curve tells us
Why would int rate be increasing over next few yrs
§
Why would ffr increase? Bc econ is doing better inflation
is stronger
§
Yield curve is mkt perception of future of econ and how fe
dwill act upon it
§
To have a downward sloping yield curve it means u have
negative outlook of future, recession will emerge fed willd
rop rates and this is why ST int rates are higher than logn
term int rates
§
○
Yield curves are almost always upward sloping bc of risk
premium attached to long end of the curve
○
2008 -- econ will go back to tits growth rate (slide fact #2 and
fact #3)
March 2008 we have dif view of eocn bc potential has
change
§
○
2017 and 2018 -- econ has been much stronger than weve
anticipated
Market participants predicted FFR to be close to 1% by
now --- FFR is 1.75
§
Mkt belief of where we should be today bc econ has been
much stronger than anticipated --- faster than otherwise
would have been done
§
○
Slope of yield curve tells u wheteher participants see con and
how fed reacts to state of econ
Easy measure of slope of yield curve is 10yr rate- 3
months rate and compute slope
§
(slide 5)
§
Slope = 1: this is dif btwn 10 yr and 3 month
§
Before every recession slope was inverted
About a year before 1990 reecession we had
inverted yield curve
□
2001 same 2008 same □
Were not predicting a recession but now slope is
slacking
□
§
○
•
Slide 7
Bookmark added at 01:10:32 in Audio 3
Yield curve is much less steep than it has been in the past, tells
u theres a prob of a recession
○
What caused slope of yield curve to constantly change?
Future expectations changed
News updates -- econ reacts□
Fed decrease rate -- econ flatten □
Interest rate □
§
○
Why should yield curve inversion lead to recession
U think econ is likel
§
○
•
BAISC MATERIAL ABOUT YIELD CURVE IS AT THE END OF MONDAYS
LECTURE
What should Jerome Powell do?
Monday, March 26, 2018
6:32 PM
The deviation of real GDP from its potential level has long been
regarded as a standard measure of economic slack
When the economy grows faster than its potential, the effects
are widespread: Overtime hours increase for workers, capital
utilization rates go up for businesses, and inflation pressures
mount for consumers.
○
Output gap- diff btwn real GDP and its potential level
Closely scrutinized by policy makers
§
○
Data on real GDP come from the National Income and Product
Accounts (NIPA) published by the Bureau of Economic Analisys
○
Data on potential GDP are revised less frequently
Potential GDP had moved slowly enough that the CBO
releases yearly updates together w 10 yr projections
§
Potential GDP can change in times of economic tumult]
§
○
•
We measure inflation using the personal consumption expenditures
price index (PCEPI) excluding food and energy. This measure is
commonly referred to as core PCE inflation.
Although the Federal Reserve is ultimately interested in
ensuring that headline inflation remains stable, core inflation is
significantly less volatile and therefore offers a more reliable
measure
○
•
CLASS NOTES
•
Audio recording started: 10:34 AM Wednesday, March 28, 2018
Audio recording started: 10:34 AM Wednesday, March 28, 2018
Audio 3
Audio recording started: 10:35 AM Wednesday, March 28, 2018
Taylor Rule
We need a measure of econ slacks and a measure of inflation
•
Slide 2
First measure of slack
○
Output gap
When econ grows faster than potential it becomes hard
for firms to meet demand and they have an incentive to
increase prices leading to further inflation
Overtime hrs increase
□
Capital util rates increase
□
Inflation pressures mount for consumers
□
Increase in AD --> increase output gap --> increase
in inflation
□
§
○
•
Slide 3
Bookmark added at 02:03 in Audio 3
○
GDP recorded quarterly
Comes roughly a month after quarter ends
§
○
Not reported frequently
In past revisions didn’t really matter
§
Although we were revising every 3 yrs big
recessions/expansions didn’t change shape of economy
or output trajectory
§
However great recession changed everything/ output
trajectory
§
○
What impact do these revisions have on output gap?
GDP has been revised downward since 2007
§
Dotted line: real GDP
§
From current GDP we are still way below potential
If we had been on same economic trajectory 2007
line is where we should be but real gdp shows
where we actually are
□
We are hyper percent above potential output□
§
If were above potential we can bring up the int rate
§
Good estimate of GDP is key in studying monetary policy
§
○
•
Slide 5
We will use an updated version of the Taylor rule
○
It= 1.25+1.5xpit +1*output gap
○
Pi is core PCE inflation, measured each month
○
What is the current prescription for the federal funds rate?
When econ is at potential output gap is 0 and inflation is
at 2
§
So FFR/it is 4.25 -- this value is what keeps econ at
potential
§
○
We use core inflation bc headline inflation is highly volatile bc
of food and energy prices
○
What is the current prescription for the FFR?
We are above the output gap (+.5)
§
Below target for inflation
§
It = 1.25 +1.5*1.5+.5 =4 --- roughly what the taylor rule is
calling the fed to do
§
○
Vintages?
If u use current potentail weve been at potential since
2017 now we are above potential
§
This corresponds w inflation #
FFR below 0 200, 2012 --- around 0 2012-2014,
increase in FFR calling for 4% in 2017 Q4
□
Way above current FFR of 1.5-1.75%□
We are so far off potential that the taylor rule is
telling the fed to cut rate way below 0 to make
econ go back to potentail I
□
What Bookmark added at 14:18 in Audio 3□
P□
§
During great recession we lost a lot of the labor force --
some bc they were close to retirement age
Bringing ppl who have not been employed can be
hard bc they may not have the skills required to
succeed
□
Trajectory itself might not have changed -- (of graph
1) what has changed is really the level
Didn’t happen in other recessions -- much
milder
®
□
§
2007 didn’t know recession would be that bad -- why
taylor rule is calling for diff FFR
§
○
•
Slide 7
Bookmark added at 17:36 in Audio 3
Dual mandate of fed is max emp and price stablitiy
○
Theres a relationship btwn low unemp and max output
○
Try to modify taylor rule to sub output gap w unemployment
gap
○
LECTURE 7 --- LABOR MKT
Using Okun's law
§
○
Adv of using unemp gap
Much more direct measure of fed's dual mandate
§
Unemp data as opposed to GDP data evolve much more
timely
§
Since beginning of feb you know january unemp rate
§
You only have info on 2018 Q1 at beginnign fo april
§
Unemp #s are much more timely
Monthly not quarterly□
We use unemp gap -- ut= headline unemployment u
bar is natural rate or NAIRU -- unemp that keeps
econ on even keel
□
§
Okun's law ---
Output gap = -2* unemployment gap □
§
○
Do output gap and unemployment gap taylor rules always call
for similar rate
If okun's law is true it should but taylor rule output gap v
unemp gap there is a divergence that emerged since the
great recession
Most of the time they called for the same FFR □
Okuns law is a pretty good rule of thumb -- come
great recession we see a big divergence
□
Output taylor rule says sm different that
unemployment taylor rule
Instead of as a measure of output gap you see
that econ is doing much worse than it usually
does
®
Output gap perspective econ is doing pretty
badly but has recovered from 2011-2012
®
Unemployment gap perspective --- took a
number of years for econ to recover
Divergence btwn the 2 -- made it hard
for fed to figure out what to do
◊
Recessions are not all good to go
◊
Right measure to put in taylor rule?
2 measures of econ slack give
very different prescriptions as to
what FFR should be
}
If you use output gap perspective
its not as bad bc firms tried to use
as much capital as possible after
they fired ppl
}
◊
®
□
§
○
•
Slide 10
○
Bookmark added at 26:40 in Audio 3
○
Uncertainty about entering job market conditions
○
Ultimately policy makers need to make jugments about how
much conflicting indicators reflect cyclical weakness in job
market
○
Why did fed keep FFR so low for so long
Recession was severe
§
Depending on which measure of econ activity youre
looking at u get dif prescription
§
Fed tried to play it safe and keep FFR low for a long time
§
Dif measures of unemp told us dif things about the state
of the labor market
§
○
Traditionally whether u look at headline unemp
Bookmark added at 28:11 in Audio 3
Usually call for all kind of policy rate bc they all move in a
similar fashion
§
○
•
Slid 13
Before great recession
Red line is headline unemp □
They are dif but all move in a similar fashion □
Come great recession things are way different □
Discrepancies btwn measures is different□
Another measure of unemp that we call non-
employment
Everyone not in the labor force -- all fo the
people who have quit + all of the unemployed
®
This measure has always followed U3
®
Unemp comes back down nonemp stays flat
bc we lost a lot ofppl that jumped out of the
labor force and never came back
®
Short term unemp is a narrower measure
®
U4 u5 u6 are broader
®
Nonemplyment is even broader
®
□
§
Do these measures also call for diff policy rates? Using
taylor rule do alt measures of labor mkt slack all call for
same FFR?
Fed miht be able to fix cyclical □
But long term -- skills required might have
changed -- can be fixed w social policy
□
§
2007 was a long lasting recession - somewhat of a
depression
Hope to bring back some people □
Slide 16-- different taylor rule prescriptions
depending on dif measures of unemp
Fed feels confident about raising the rate
®
All equations tell us to raise the rate
®
Althoughwere at potential we don’t see it
picking up
®
Bookmark added at 38:16 in Audio 3
®
Were able to attract ppl from outside of labor
force to join
Also having impact on U6
Taking ppl unemp making them
eployed
}
Also ppl whow ere unemp and
putting them back in labor force
Fixing structural issues
–
Fixing the labor force as
much as possible
–
}
◊
®
□
§
Slide 14
Bookmark added at 39:55 in Audio 3
Decline in labor force participation rate
§
As discrimination policy broke down we see an increase
but since 2007 there is a decrease
Permanent shift? Yes
Aging of population
®
Milenialls don’t want to work as much as
their parents
®
Shift that has to do w mentality
®
Ppl in new generation don’t want to work
that much
New generation is notw illing to work
40 hrs
◊
®
□
§
○
Slide 17
Bookmark added at 43:18 in Audio 3
Which measure of unemp is best
§
Bookmark added at 47:36 in Audio 3
Which emesure of unemp is best?
None of them□
All say sm different□
Divergent so FOMC must make judgement about
what each message is sending
□
Decide what the conflicting signals refelct?
Cyclical weakness
®
Permanent structural factors
®
□
Relying on rule driven by single market indicator
has become more difficult
Recession was a change in mentality, culture,
demographics
®
Hard fo rfed to absorb everything
®
□
§
Might as well use U3
Bookmark added at 49:38 in Audio 3□
Now ere at a stage where it seems theyre coming
back to have same relationship they once had
As long as relationship is the same it
shouldn’t matter which u use (this is what
graph 5 shows -- slide 16) they all call for
same FFR
®
□
Ppl who arent in LF reflects a structural issue not
cyclcical
□
§
○
Slide 18
Bookmark added at 51:12 in Audio 3
§
A strong dollar elads americans to purchase goods and
services for cheap leading to lwoer inflation
§
A strong dollar also makes us good esxpensive for
foreigners they mightnt by as many leading to lower
exports, net exports, aggregate demand which leads to
lower ouput and inflation
§
State of us dollar relative to other currencies in the world
as well as stae of global econ also has impact on US econ
and monetary policy
§
How does current strength..
Bookmark added at 53:01 in Audio 3□
Yr ago global eocn wasn’t doing very well this year
it is doing well
□
Impact of synchronized global econ on US output
and inflation?
When rest of world does well they buy more
goods and services (and more US goods and
services) this drives up AD when rest of world
and US is doing well so price of global
commodities will go up so it increases
inflation
®
□
Trade tensions?
If you impose tariffs on a country like china
you buy less which will then decrease imports
®
Retailiation from china -- they buy less goods
and services
Negative impact on output
◊
®
Tariffs on chines goods makes it more
expensive
Supply shock (inc inflation, decreasing
output) … just like an oil price shock
◊
What does this imply for US monetary
policy and FFR
◊
®
□
§
○
Slide 19
If change sin monetary policy led to …
§
Bookmark added at 56:15 in Audio 3
§
Should fed be more aggressive in normalizing the FFR?
Risk of doing it too early? Risk of waiting too long?
Bookmark added at 56:44 in Audio 3□
Takes a yr or 2 for impact of monetary policy to
feed into econ
□
There is a downside of waiting too long or going to
early
□
Trend is important□
§
○
Slide 20
Bookmark added at 57:58 in Audio 3
§
Fed wabted ti reoakce FOMC w a computer
§
Why hasn’t the fed put the taylor rule on autopilot?
Is there more to monetary policy than this equation □
There are shocks -- withoutu someone there
looking at what is happening then you could end up
with something that isnt the right thing to do
□
§
○
Sldie 21
Bookmark added at 01:00:27 in Audio 3
§
What should jay powell do? --- look for this on final
§
○
•
CASTE STUDY #2
•
Bookmark added at 01:01:12 in Audio 3•
Yield curve is the yield of types of bonds of diff maturity•
Mkt for govt bonds
Yield curve is just the yield that the bond gives at diff maturities
○
Yield on 10yr treasury is about 10.9%
○
Yield on 3 month treasury is about 1.75%
○
Yield curve is simply telling u the yield for bonds that are
comparable at different maturities
○
The FFR is very similar to 3 3month treasury bc for a comm bank
u can either lend to the govt at 3 mo rate or go in FFMarket and
roll over cash at FFR for 6 weeks
In 6 weeks FOMC will meet again only gonna go up or
down by 10 poitns
§
Substitute for commercial banks in terms of lending
opportunities
§
○
•
Yield curve tells us that if as comm bank u can roll cash around for 3
mos?
Slope of yield curve tells us
Why would int rate be increasing over next few yrs
§
Why would ffr increase? Bc econ is doing better inflation
is stronger
§
Yield curve is mkt perception of future of econ and how fe
dwill act upon it
§
To have a downward sloping yield curve it means u have
negative outlook of future, recession will emerge fed willd
rop rates and this is why ST int rates are higher than logn
term int rates
§
○
Yield curves are almost always upward sloping bc of risk
premium attached to long end of the curve
○
2008 -- econ will go back to tits growth rate (slide fact #2 and
fact #3)
March 2008 we have dif view of eocn bc potential has
change
§
○
2017 and 2018 -- econ has been much stronger than weve
anticipated
Market participants predicted FFR to be close to 1% by
now --- FFR is 1.75
§
Mkt belief of where we should be today bc econ has been
much stronger than anticipated --- faster than otherwise
would have been done
§
○
Slope of yield curve tells u wheteher participants see con and
how fed reacts to state of econ
Easy measure of slope of yield curve is 10yr rate- 3
months rate and compute slope
§
(slide 5)
§
Slope = 1: this is dif btwn 10 yr and 3 month
§
Before every recession slope was inverted
About a year before 1990 reecession we had
inverted yield curve
□
2001 same 2008 same □
Were not predicting a recession but now slope is
slacking
□
§
○
•
Slide 7
Bookmark added at 01:10:32 in Audio 3
Yield curve is much less steep than it has been in the past, tells
u theres a prob of a recession
○
What caused slope of yield curve to constantly change?
Future expectations changed
News updates -- econ reacts□
Fed decrease rate -- econ flatten □
Interest rate □
§
○
Why should yield curve inversion lead to recession
U think econ is likel
§
○
•
BAISC MATERIAL ABOUT YIELD CURVE IS AT THE END OF MONDAYS
LECTURE
What should Jerome Powell do?
Monday, March 26, 2018 6:32 PM
The deviation of real GDP from its potential level has long been
regarded as a standard measure of economic slack
When the economy grows faster than its potential, the effects
are widespread: Overtime hours increase for workers, capital
utilization rates go up for businesses, and inflation pressures
mount for consumers.
○
Output gap- diff btwn real GDP and its potential level
Closely scrutinized by policy makers
§
○
Data on real GDP come from the National Income and Product
Accounts (NIPA) published by the Bureau of Economic Analisys
○
Data on potential GDP are revised less frequently
Potential GDP had moved slowly enough that the CBO
releases yearly updates together w 10 yr projections
§
Potential GDP can change in times of economic tumult]
§
○
•
We measure inflation using the personal consumption expenditures
price index (PCEPI) excluding food and energy. This measure is
commonly referred to as core PCE inflation.
Although the Federal Reserve is ultimately interested in
ensuring that headline inflation remains stable, core inflation is
significantly less volatile and therefore offers a more reliable
measure
○
•
CLASS NOTES
•
Audio recording started: 10:34 AM Wednesday, March 28, 2018
Audio recording started: 10:34 AM Wednesday, March 28, 2018
Audio 3
Audio recording started: 10:35 AM Wednesday, March 28, 2018
Taylor Rule
We need a measure of econ slacks and a measure of inflation •
Slide 2
First measure of slack
○
Output gap
When econ grows faster than potential it becomes hard
for firms to meet demand and they have an incentive to
increase prices leading to further inflation
Overtime hrs increase□
Capital util rates increase□
Inflation pressures mount for consumers□
Increase in AD --> increase output gap --> increase
in inflation
□
§
○
•
Slide 3
Bookmark added at 02:03 in Audio 3
○
GDP recorded quarterly
Comes roughly a month after quarter ends
§
○
Not reported frequently
In past revisions didn’t really matter
§
Although we were revising every 3 yrs big
recessions/expansions didn’t change shape of economy
or output trajectory
§
However great recession changed everything/ output
trajectory
§
○
What impact do these revisions have on output gap?
GDP has been revised downward since 2007
§
Dotted line: real GDP
§
From current GDP we are still way below potential
If we had been on same economic trajectory 2007
line is where we should be but real gdp shows
where we actually are
□
We are hyper percent above potential output
□
§
If were above potential we can bring up the int rate
§
Good estimate of GDP is key in studying monetary policy
§
○
•
Slide 5
We will use an updated version of the Taylor rule
○
It= 1.25+1.5xpit +1*output gap
○
Pi is core PCE inflation, measured each month
○
What is the current prescription for the federal funds rate?
When econ is at potential output gap is 0 and inflation is
at 2
§
So FFR/it is 4.25 -- this value is what keeps econ at
potential
§
○
We use core inflation bc headline inflation is highly volatile bc
of food and energy prices
○
What is the current prescription for the FFR?
We are above the output gap (+.5)
§
Below target for inflation
§
It = 1.25 +1.5*1.5+.5 =4 --- roughly what the taylor rule is
calling the fed to do
§
○
Vintages?
If u use current potentail weve been at potential since
2017 now we are above potential
§
This corresponds w inflation #
FFR below 0 200, 2012 --- around 0 2012-2014,
increase in FFR calling for 4% in 2017 Q4
□
Way above current FFR of 1.5-1.75%
□
We are so far off potential that the taylor rule is
telling the fed to cut rate way below 0 to make
econ go back to potentail I
□
What Bookmark added at 14:18 in Audio 3
□
P
□
§
During great recession we lost a lot of the labor force --
some bc they were close to retirement age
Bringing ppl who have not been employed can be
hard bc they may not have the skills required to
succeed
□
Trajectory itself might not have changed -- (of graph
1) what has changed is really the level
Didn’t happen in other recessions -- much
milder
®
□
§
2007 didn’t know recession would be that bad -- why
taylor rule is calling for diff FFR
§
○
•
Slide 7
Bookmark added at 17:36 in Audio 3
Dual mandate of fed is max emp and price stablitiy
○
Theres a relationship btwn low unemp and max output
○
Try to modify taylor rule to sub output gap w unemployment
gap
○
LECTURE 7 --- LABOR MKT
Using Okun's law
§
○
Adv of using unemp gap
Much more direct measure of fed's dual mandate
§
Unemp data as opposed to GDP data evolve much more
timely
§
Since beginning of feb you know january unemp rate
§
You only have info on 2018 Q1 at beginnign fo april
§
Unemp #s are much more timely
Monthly not quarterly□
We use unemp gap -- ut= headline unemployment u
bar is natural rate or NAIRU -- unemp that keeps
econ on even keel
□
§
Okun's law ---
Output gap = -2* unemployment gap □
§
○
Do output gap and unemployment gap taylor rules always call
for similar rate
If okun's law is true it should but taylor rule output gap v
unemp gap there is a divergence that emerged since the
great recession
Most of the time they called for the same FFR □
Okuns law is a pretty good rule of thumb -- come
great recession we see a big divergence
□
Output taylor rule says sm different that
unemployment taylor rule
Instead of as a measure of output gap you see
that econ is doing much worse than it usually
does
®
Output gap perspective econ is doing pretty
badly but has recovered from 2011-2012
®
Unemployment gap perspective --- took a
number of years for econ to recover
Divergence btwn the 2 -- made it hard
for fed to figure out what to do
◊
Recessions are not all good to go
◊
Right measure to put in taylor rule?
2 measures of econ slack give
very different prescriptions as to
what FFR should be
}
If you use output gap perspective
its not as bad bc firms tried to use
as much capital as possible after
they fired ppl
}
◊
®
□
§
○
•
Slide 10
○
Bookmark added at 26:40 in Audio 3
○
Uncertainty about entering job market conditions
○
Ultimately policy makers need to make jugments about how
much conflicting indicators reflect cyclical weakness in job
market
○
Why did fed keep FFR so low for so long
Recession was severe
§
Depending on which measure of econ activity youre
looking at u get dif prescription
§
Fed tried to play it safe and keep FFR low for a long time
§
Dif measures of unemp told us dif things about the state
of the labor market
§
○
Traditionally whether u look at headline unemp
Bookmark added at 28:11 in Audio 3
Usually call for all kind of policy rate bc they all move in a
similar fashion
§
○
•
Slid 13
Before great recession
Red line is headline unemp □
They are dif but all move in a similar fashion □
Come great recession things are way different □
Discrepancies btwn measures is different□
Another measure of unemp that we call non-
employment
Everyone not in the labor force -- all fo the
people who have quit + all of the unemployed
®
This measure has always followed U3
®
Unemp comes back down nonemp stays flat
bc we lost a lot ofppl that jumped out of the
labor force and never came back
®
Short term unemp is a narrower measure
®
U4 u5 u6 are broader
®
Nonemplyment is even broader
®
□
§
Do these measures also call for diff policy rates? Using
taylor rule do alt measures of labor mkt slack all call for
same FFR?
Fed miht be able to fix cyclical □
But long term -- skills required might have
changed -- can be fixed w social policy
□
§
2007 was a long lasting recession - somewhat of a
depression
Hope to bring back some people □
Slide 16-- different taylor rule prescriptions
depending on dif measures of unemp
Fed feels confident about raising the rate
®
All equations tell us to raise the rate
®
Althoughwere at potential we don’t see it
picking up
®
Bookmark added at 38:16 in Audio 3
®
Were able to attract ppl from outside of labor
force to join
Also having impact on U6
Taking ppl unemp making them
eployed
}
Also ppl whow ere unemp and
putting them back in labor force
Fixing structural issues
–
Fixing the labor force as
much as possible
–
}
◊
®
□
§
Slide 14
Bookmark added at 39:55 in Audio 3
Decline in labor force participation rate
§
As discrimination policy broke down we see an increase
but since 2007 there is a decrease
Permanent shift? Yes
Aging of population
®
Milenialls don’t want to work as much as
their parents
®
Shift that has to do w mentality
®
Ppl in new generation don’t want to work
that much
New generation is notw illing to work
40 hrs
◊
®
□
§
○
Slide 17
Bookmark added at 43:18 in Audio 3
Which measure of unemp is best
§
Bookmark added at 47:36 in Audio 3
Which emesure of unemp is best?
None of them□
All say sm different□
Divergent so FOMC must make judgement about
what each message is sending
□
Decide what the conflicting signals refelct?
Cyclical weakness
®
Permanent structural factors
®
□
Relying on rule driven by single market indicator
has become more difficult
Recession was a change in mentality, culture,
demographics
®
Hard fo rfed to absorb everything
®
□
§
Might as well use U3
Bookmark added at 49:38 in Audio 3□
Now ere at a stage where it seems theyre coming
back to have same relationship they once had
As long as relationship is the same it
shouldn’t matter which u use (this is what
graph 5 shows -- slide 16) they all call for
same FFR
®
□
Ppl who arent in LF reflects a structural issue not
cyclcical
□
§
○
Slide 18
Bookmark added at 51:12 in Audio 3
§
A strong dollar elads americans to purchase goods and
services for cheap leading to lwoer inflation
§
A strong dollar also makes us good esxpensive for
foreigners they mightnt by as many leading to lower
exports, net exports, aggregate demand which leads to
lower ouput and inflation
§
State of us dollar relative to other currencies in the world
as well as stae of global econ also has impact on US econ
and monetary policy
§
How does current strength..
Bookmark added at 53:01 in Audio 3□
Yr ago global eocn wasn’t doing very well this year
it is doing well
□
Impact of synchronized global econ on US output
and inflation?
When rest of world does well they buy more
goods and services (and more US goods and
services) this drives up AD when rest of world
and US is doing well so price of global
commodities will go up so it increases
inflation
®
□
Trade tensions?
If you impose tariffs on a country like china
you buy less which will then decrease imports
®
Retailiation from china -- they buy less goods
and services
Negative impact on output
◊
®
Tariffs on chines goods makes it more
expensive
Supply shock (inc inflation, decreasing
output) … just like an oil price shock
◊
What does this imply for US monetary
policy and FFR
◊
®
□
§
○
Slide 19
If change sin monetary policy led to …
§
Bookmark added at 56:15 in Audio 3
§
Should fed be more aggressive in normalizing the FFR?
Risk of doing it too early? Risk of waiting too long?
Bookmark added at 56:44 in Audio 3□
Takes a yr or 2 for impact of monetary policy to
feed into econ
□
There is a downside of waiting too long or going to
early
□
Trend is important□
§
○
Slide 20
Bookmark added at 57:58 in Audio 3
§
Fed wabted ti reoakce FOMC w a computer
§
Why hasn’t the fed put the taylor rule on autopilot?
Is there more to monetary policy than this equation □
There are shocks -- withoutu someone there
looking at what is happening then you could end up
with something that isnt the right thing to do
□
§
○
Sldie 21
Bookmark added at 01:00:27 in Audio 3
§
What should jay powell do? --- look for this on final
§
○
•
CASTE STUDY #2
•
Bookmark added at 01:01:12 in Audio 3•
Yield curve is the yield of types of bonds of diff maturity•
Mkt for govt bonds
Yield curve is just the yield that the bond gives at diff maturities
○
Yield on 10yr treasury is about 10.9%
○
Yield on 3 month treasury is about 1.75%
○
Yield curve is simply telling u the yield for bonds that are
comparable at different maturities
○
The FFR is very similar to 3 3month treasury bc for a comm bank
u can either lend to the govt at 3 mo rate or go in FFMarket and
roll over cash at FFR for 6 weeks
In 6 weeks FOMC will meet again only gonna go up or
down by 10 poitns
§
Substitute for commercial banks in terms of lending
opportunities
§
○
•
Yield curve tells us that if as comm bank u can roll cash around for 3
mos?
Slope of yield curve tells us
Why would int rate be increasing over next few yrs
§
Why would ffr increase? Bc econ is doing better inflation
is stronger
§
Yield curve is mkt perception of future of econ and how fe
dwill act upon it
§
To have a downward sloping yield curve it means u have
negative outlook of future, recession will emerge fed willd
rop rates and this is why ST int rates are higher than logn
term int rates
§
○
Yield curves are almost always upward sloping bc of risk
premium attached to long end of the curve
○
2008 -- econ will go back to tits growth rate (slide fact #2 and
fact #3)
March 2008 we have dif view of eocn bc potential has
change
§
○
2017 and 2018 -- econ has been much stronger than weve
anticipated
Market participants predicted FFR to be close to 1% by
now --- FFR is 1.75
§
Mkt belief of where we should be today bc econ has been
much stronger than anticipated --- faster than otherwise
would have been done
§
○
Slope of yield curve tells u wheteher participants see con and
how fed reacts to state of econ
Easy measure of slope of yield curve is 10yr rate- 3
months rate and compute slope
§
(slide 5)
§
Slope = 1: this is dif btwn 10 yr and 3 month
§
Before every recession slope was inverted
About a year before 1990 reecession we had
inverted yield curve
□
2001 same 2008 same □
Were not predicting a recession but now slope is
slacking
□
§
○
•
Slide 7
Bookmark added at 01:10:32 in Audio 3
Yield curve is much less steep than it has been in the past, tells
u theres a prob of a recession
○
What caused slope of yield curve to constantly change?
Future expectations changed
News updates -- econ reacts□
Fed decrease rate -- econ flatten □
Interest rate □
§
○
Why should yield curve inversion lead to recession
U think econ is likel
§
○
•
BAISC MATERIAL ABOUT YIELD CURVE IS AT THE END OF MONDAYS
LECTURE
What should Jerome Powell do?
Monday, March 26, 2018 6:32 PM
