okay let's uh let's start so by now uh you know the is Mo and if you don't fully control it please spend a lot of time on it um as I said two third of your quiz will be about that but uh we're going to start adding a few it's a very basic model but still H we can squeeze a lot of insight from it and uh and there are some very natural extensions that that I think we should also go over and and cover because uh again they have a high return in terms of investment to to knowledge you acquir from them and today I want to extend this islm model along two realistic Dimensions the first one ER is H is to make a distinction between nominal and real interest rate now nominal up to now since we assume in the mod since we assume that prices were completely fixed constant there's no inflation and then there is no distinction between nominal and real interest rates but needless to say we live in an environment with inflation is positive typically not always but typically and in fact nowadays we're having very high inflation and that's part of one of the big macroeconomic headaches that we have at this moment is the very high inflation rate we're experiencing now we're not going to talk about the determination of inflation until later in the course I'm going to start talking about that in the next lecture and it will not be part of your quiz though sorry not in the next next week but will not be part of your of of your quiz it will be very important part of quiz to but not of quiz one but I still can we can still say a few things about what happens to the framework we have conditional or taking as a parameter inflation we're not going to determine inflation the M but we say well what happens is inflation is not really zero more importantly what happens if people don't expect inflation to be really zero and and and we'll see how that modifies the analysis the second the second extension is is that that you know we simplify financial markets enormously and and and the and we targeted we customiz it to we could have simplified along many dimensions but the simplification that we had is we look at something that that that is closest to what central banks do in setting monetary policy and that's really the trade between cash deposit at the central bank and bonds US government bonds in the case of the US typically of very short maturity and that's what we had in mind H and that's that's the way we determine the interest rate now needless to say there are many many interest rates in the economy different duration you know one year rate twoe rate three 10 30 year rates some countries have 100 Year rates er er but there is also another dimension which is very important as the want to highlight there which is riskiness US Treasury bonds especially of short duration are riskless assets there no risk associated to it now we have a little event with the with the dead ceiling fight in in that may happen in August September but I mean nobody's really concerned that something major will happen except for a few disruptions for a few days let's hope that's true up to now if you look at all the risk markets there behaving as nothing will happen there um but but corporations don't typically borrow at those rates Corporation issue their own bonds or take loans from the banks and those bonds often have a risk premium that is they're equal to the safe interest rate the treasury rate if you want plus something else okay and and and so that you can anticipate that that will be important because interest rate enter into our islm analysis precisely through the borrowing cost of firms in the investment function so if there is a wtge there if there's a spread between what the rate we been talking about and the rate at which firms can actually borrow then that W will matter okay and uh and so that's that's what we're want to do so we're going to introduce this I'm want to explain what these things are and then I'm going to modify our islm model to take into consideration these extensions okay H so what is the nominal interest rate well we have been talking about the nominal interest rate we which we typically denote by little I is the interest rate in terms of dollars say if the interest rate is 10% no you buy a bond today that Bond will give you 10% of whatever amount of money you invest in the bond at the end of the year say it's a onee b okay that's a nominal interest rate um so if you buy 100 in bonds today and the interest rate is 10 the nominal interest rate 10% you receive $10 of interest payments one year from now $10 of Interest payment okay a real interest rate is the interest rate in terms of a basket of goods okay so the CPI or something like that will will be important in that okay exante that is at the moment in which you decided were to invest in the real Bond or the nominal Bond the difference between the two the main difference there are other issues that have to do with Reem I'm not going to talk about but the main difference between these two is expected inflation okay in other words if you expect no inflation then the distinction between goods that is if you expect P to remain constant the distinction between an interest rate in dollars or in h Goods is inexistent they're the same but if you expect inflation then that's not the case because the goods are going to become more expensive over time and if the goods become more expensive over time that means something that pays you in dollars is paying you more per equal units so if the r little r which is the interest rate is equal to I and you expect inflation to be 10% really you're expecting the real instrument to pay you 10% more than the other that cannot happen in equilibrium but that's what it means no because one is paying you in dollars and the other one is paying you in Goods that will be 10% more expensive next year okay good so why do we care about this distinction between nominal and real interest rate well because the private sector ER important decisions of the private sector like the purchase of durable goods for consumers we're not modeling that in this course but investment in the case of phisical investment not Financial investment phisical investment depends on real rates not nominal rates okay so what what what determines whether H the opportunity cost of a real investment is high or low is the real interest rate not the nominal interest rate why do you think that's the case why do you think it's the real not the nominal interest rate that matters not really I mean most of the borrowing in the US is done in nominal rates so it has to come from something else why why do you invest you invest to produce more Goods in the future so if those goods are going to be more expensive in the future because of inflation then what matters to you is the difference between the cost of borrowing and what you'll get for those goods and the goods are going to be 10% more expensive so what really matter is the net for you you know if then if in other words if the real interest remains constant and now you give me interest rates are 10% higher but you also tell me that the goods I'm going to be selling are going to be 10% more expensive I I don't change my decision if it was a good project with zero inflation it's also a good project with 10 10% inflation that hasn't changed I tell you 30% the same thing no because I'm going to be investing now in order to get things are going to be 30% more expensive a year from now so the de ision that doesn't depend on that so that's the reason the real interest rate is what you really care about in the case of real investment and remember we're talking about real investment at the aggregate level obious can make a difference at the level of individual Goods because you know when inflation goes up not every Goods price go up by the same amount some some goods go up by more some some Goods prices go up by less but on average it's what I just said so let's let's try to look at this equivalence more formally how to derive the real interest rate well in I said not in the US but in many places you do re borrow in real terms for example in in Chile we have a a unit of account because we had very high inflation many years back which is called unid fomento and that in that unit of account is indexed to inflation okay so you borrow you know uh $10 million equivalent in a formento and those 10 million pesos equivalent formento that means the interest rate is is indexed to that but in the US that happens very rarely the US government does do that it's called tips so so you have nominal bonds the great majority of the US Treasury bonds are nominal bonds but there are also some real bonds and those are indexed to inflation but but but firms very rarely can issue Bonds in the US that are in real terms okay that's so let's sometimes this is even a so but the point the reason I I made that clarification here is I'm going to derive the real interest rate but that doesn't mean that the instrument exists you know I'm saying given a nominal rate that I see out there how do I construct a real interest rate from that nominal interest rate that's what I want to hear it doesn't mean that there's an instrument that is traded in in real terms but when I go to the the bank as a firm and I borrow a 10% nominal I need to calculate well what does that imply in real terms and that's what I'm going to illustrate now okay so good so or maybe I shouldn't use the word good since we're going to do this so what we want to pin down this this this real interest rate R okay so the real interest rate in terms of goods means if I borrow say one unit or if I buy a a an instrument that if I spend one unit of the good the aggregate good in a bond then I I receive one plus RT units of goods H one year from now then RT is the real interest rate no it's an interest rate in terms of goods now suppose that that I go this route instead say okay that's what I want to get to but um let me do it through the only instrument I have say the nominal interest rate the nominal bonds so if I buy one unit of goods today that means I'm really buying PT dollars in that Bond okay PT is the deflator we have we have PT dollars well PT dollars invested in a nominal Bond will give me 1 plus it the nominal interest rate times those PT dollars okay so say the price index here is is two then uh and the interest rate is 10 the nominal interest rate 10% then next period I get a two * 1.1 okay that's the number of dollars I get now that's still I cannot compare this with the with this up here because at this point I have dollars and really I want to convert it into Goods I want to go from Goods to Goods so how do I convert dollars into Goods I divide by the price of the goods but not here by the price of the goods at t plus one because I'm going to get this amount of dollars at t+1 one year from now I have to divide by the price of goods at t+ one in order to get the number of goods I'm getting a t plus one so I have to divide by p+ one but the problem is that time T I don't know what pt+ one will be okay the best I can do and here's where I'm I'm simplifying things a lot is to is to have an expectation of what the price level will be one year from now so the best I can do when I want to compare things today whether I want to go this way or that way is to a er use suspected price here okay so these two things are equivalent in the sense that they require exactly the same investment I'm now I'm going this way and then in expectation at least these two things are also equivalent okay because this is what I'm going to get in terms of goods from having invested a good this what I expect to get in terms of goods but I'm ignoring all that uncertainty around that H and this is what I get if I go directly the route the the Goods Route and and this is two things are to be equal by indifference okay I if I two things give me the same they have to be priced equally they have to have the same price and so these two things have to be the same because here I'm going from Goods to Goods here I'm going through this channel but also from Goods to Goods these two things should give us more or less the same return okay and we're going to assume strictly that they give us the same expected return okay so this relationship holds is this di clear diagram clear okay good because what I'm going to do now is I'm going to take this expression here and play with it a little so we arve in the previous slide to the conclusion that 1 plus the real interest rate is equal to 1 plus plus the nominal interest rate time PT over PT + one expected I'm going to denote expected inflation the inflation we expect the change in the the the log change in the price level or the rate of change of the price level from year T to year t+1 as Pi e t+1 is equal to that okay so this is expected inflation at t+ one see that well do a little algebra and I can rewrite this guy here as 1 plus expected inflation between t and t plus one okay I just I just replace this for one one over 1+ pi+ one okay just algebra I got that so now I have relationship and these things if they if this interest rate is not too high this in expected inflation is not too high not too large as it happens in most countries but a few around the world then this is approximate implies approximately that the real interest rate is approximately equal to the nominal interest rate minus expected inflation okay I'm just taking approximations here okay and that's is an intuitive expression the real interest rate is equal to the nominal rate minus expected inflation so if if the interest rate is is 6% and expected inflation is 3% well the real interest rate is only 3% okay in terms of good you're going to get 3% less because that's inflation rate good or if you're borrowing in terms of your borrowing cost well it's going to cost you 3% less effectively because the goods you're going to be in selling out of your investment are Al are going to be 3% more expensive good so look this is what happened I'm showing you what happened around the years of the Great Recession remember the Great Recession happened 20 end of 2008 2009 2010 several things you can see in this picture ER the white line here is the nominal interest rate and the yellow is the real interest rate in the US okay and and this is a since in the US you can actually trade real and nominal bonds the difference between these two is expected inflation okay as as priced by financial markets they're called in the US they're called inflation break evens these are swaps inflation swaps okay inflation break evens but anyways so several things you can see in this picture the first one is that typically typically the unless you're in Japan probably the the the the white line that is a nominal rate is above the orange line which is or the yellow line which is the real interest rate why do you think that's the case or what does it tell you the fact that on average sort of er the nominal interest rate is above the real interest rate yeah on average in most advanced economies and even more so in Emerging Markets inflation is positive and therefore people expect inflation to be positive okay yeah in Japan went through these long periods of deflation but that's a rarity that was an anomaly what was going on in Japan but you see something else here there's an episode very clearly when the opposite was holding no when the real interet went much higher than the nominal interest rate and this is despite the fact that you see even they cross in opposite direction here there was a sharp decline in the nominal interest rate and a sharp rise in the real interest rate what happened what was happening there first of all forget about the picture what was happening around 2008 2009 the Great Recession okay so that's one observation typically especially modern recession certainly recessions caused by financial crisis as this one was a a um real interest go above nominal interest rate can go above nominal interest rates what does it mean in terms of inflation I mean remember what the FED is setting is this is this one more or less this I think is a one-ear rate so it's not exactly what the FED said but more or less okay so why do you think the FED cut interest rate there very aggressively yeah we were in the middle of a big financial crisis so we wanted to boost the economy no so interest rate and this is when you map it into into the very short rate this is effectively they hit the zero lower bound they couldn't lower it more they lower it as much as they could and that was it so what must have happened for this real interest rate to go up like crazy how can it be there the FED Bringing Down the nominal interest rate and the real rate boom jumps up expected inflation went down and L so what I was saying is in expected inflation is typically positive in in in sort of developed economies around 2% two and a half perc that's the type of numbers but in deep recessions it can go even negative okay and that's what happen there is the expected inflation as extracted from inflation break evens from these swaps and you see you know typically it's around 2% and so on because that's more or less the the the FED inflation Target in the US okay but during this episode here we enter into a very deflationary episode expected inflation close to minus 4% that was very deflationary was very scary deflations can be very complicated objects to deal with ER we'll say more about that later okay but that's that's what happened there good so that's that's nominal versus real interest rate now let me talk about credit spread and then we're going to put everything together so most bonds issued by corporations are risky they are not us Treasures are as safe as it gets that's consider the safest Assets in the world together with German bond market bonds you know government bonds and SS and there are a few but but the US in terms of liquidity everything is the Premier safe asset in the world okay but most corporations don't issue at those rates they have to pay a premium because they're not as safe as as those as the treasury instrument so let me call that the real interest rate paid by this uh bonds by issues by firms on average be equal to the safe real interest rate plus a premium XT okay now the point and is important is that this risk premium moves a lot over the business cycle especially when you have a financial crisis you know people really want to run away from risk now and and and so it tends to be higher during recessions especially when recessions are caused by financial crisis and things of that kind now why do we care about the risk premium again because important private sector decisions depend on that real interest rate on the on on the on the risk adjusted interest rate okay if a firm has lots of credibility problems and is considered very risky the cost of borrowing is going to be very high and therefore it's going to have to have a higher threshold for any physical investment no it's more costly for that firm to borrow so that's a reason to worry so the risk premium is that X there is determined by two things essentially in in the case of bonds there's also risk premiums in equity but in the case of bonds one thing is the priority of theault I mean it may be that the firm doesn't honor those BS and defaults on them okay so one thing is a primary default the other one is the degree of risk aversion of bone bone holders there are sometime times in which you say look I don't want to hold any risk here or very little risk because you know everything looks very complicated to me I rather go safe I go to treasury bonds I don't want this stuff so those two reasons make that spread grow the second reason on average to me is the most important reason but it's easier to model all this stuff as a priority of the fault so that's what I'm going to assuming what I'm going to do here is I'm going to ignore this the degree of risk aversion of bond holders and I'm going to just concentrate on the probability of theault of a bond but in a sense you can model both as the same because you can think of risk aversion as somebody exaggerating the probability of the fault of a bond if I if I get very nervous about investing in Risky stuff there is some true probability of the fault that some agenci is calculating out there but if I'm very nervous about that I may as well put a markup say well you know these guys have messed up in the past they may think that the probility def fall of this bond is 5% during the next year I'm going to treat it as 10% okay because I want to penalize for the risk I'm incurring so so think of this P here as a probity of theault but as perceived by in you don't know the what is the true probity of theault that's a abstract concept no but it's whatever you use in your investment decisions that I'm modeling here so by the same principle we had before between nominal and real bonds what we need to have is is I need to be different in equilibrium I need to be different between H investing in in in treasury bonds the safe bonds that pay an interest RT and investing in Risky bonds that are paying an interest rate RF which is greater than a RT no so I have to be indiffer between these two things and the and the the spread here will have to adjust so I'm indifferent between these two things indeed it's obvious if the probability of default is greater than zero that this RF is going to have to be greater than R because otherwise I don't you know I don't want to invest in a bond that pays me the same as that and on top of that I I I can experience a default occasion don't get my money back okay so what we have here this indifference condition means okay during the next year there's a probability to the fall p that means with probability one minus P I'm going to get this High interest rate I'm going to get my money back I invest one in a bond I get my money back plus an interest rate Which is higher than the safe interest rate is our F okay that's a good thing against that is there's a probability that the bone there's a default and I'm going to assume always in practice there is some recovery of a bone which is much less than the principal I'm going to assume it's zero okay so if p is positive as I said before then it better be the case that this f is greater than R otherwise I'm not going to invest anything in the risky Bond so I'm going to replace just this RF by RT plus X just to calculate XT and you can solve this out here and you get that this risk premium is XT is an increasing function of P okay naturally if this if I perceive bonds to be more likely to default and when I require a higher compensation if the bond doesn't default okay and that's what we we have here now during what happens is that during severe recessions actual defaults go up so the probability of theault objectively goes up and people get a lot more scared also that this will happen and so P tends to go up a lot okay so during SE severe recessions but is is always almost in recession but especially in severe recessions P can rise a lot okay it can rise a lot R may fall or not we shall see but but this stuff dominates actually okay so this credit this x can move up a lot during recessions and in fact if I show you what happened during the gr recession same episode as before there you have it this is our X really okay look how it jump during 2008 okay so uh the average and this is for I think it's high yield I think but it's not junk it's high yield though ER I think it's a it's a it's a weighted average of things but think of this as the median bond out there corporate bond ER it had to pay 20% more than a treasury bond okay so big difference if you are in the private sector and wanted to borrow than if the government wanted to borrow big thing this was a big issue good now it's all almost always oh but that level this is high yield H so you see typically because this high yield these are not the the primest companies H they have a vary of default there's a risk out there they typically have to pay a spread 3% 4% things like that but during severe events that can go very very high so if you're a corporation and you're trying to borrow here it's going to be pretty difficult to borrow that's the point okay not a good time to invest in that sense it's going to be pretty expensive so that takes me to the slm mod I want to sort of now bring in these two ingredients so the two modifications I introduce are relevant for the is the LM doesn't change the Central Bank keeps setting the nominal interest rate and that's what it does okay so that's not changing and that's the target of the Central Bank the the Central Bank may decide to react to things that happen in expected inflation and cre spread but the LM is is the same as it used to be in the book at some point make the book makes a simplification and it starts setting the interest rate in terms of the real interest rate I think that's a bad idea so I'm not going to do that okay I'm going to keep our is our LM as it was but now with this extensions we have to modify well the only place where interest rate enters for us which is in the investment function and so the investment function now is not a function of the nominal interest rate it's a function of the real interest rate adjusted by credit risk because that's the relevant opportunity cost of that's a real cost of borrowing if you will of firms when they want to invest okay so that's a modification now for this part of the course as I said I'm going to take this as two new parameters we're not going to look at equilibrium determination of that when we get into the next part of the course then we're never going to do much about that but yes about this but for now these are just two new parameters so in our equilibrium in lecture three in the goods market equilibrium now we have two more parameters expected inflation and in the remember the ZZ curve where we have GT interest rate all those things has constant well now we have two new parameters expected inflation and the credited spread okay so that's it that's lecture three now so what I'm showing you here is what happened in lecture three if the credit spreads comes down or expected inflation Rises for any given nominal interest rate okay then that shift the ZZ curve up why is that and sorry and if aggregate demand goes up then the multiply it kicks in and we end up with an expansion in output so I'm saying for a given nominal interest rate if now expected inflation goes up or H the credit spreads spreads go down then we that's act acts almost like an expansionary monetary policy you see you get an expansion in aggregate demand yes for RIS deine they can they can borrow exactly that's it yes because of borrowing went up for down for firms okay so that's what I'm saying those two things operate almost as monetary policy that is not been done by the fed by the way by the central bank but they have the same effect because that's the way they enter they enter exactly the same as as an interest rate so saying that this guy is going up or this guy is going down leads to the same analysis as as as when we lower I because they're identical they enter exactly in the same place no so what I showed you here I had done diagrams like this before that's what you get when you lower the interest rate well the the two shocks I describ is effectively like lowering the interest rate that is the relevant interest rate for a a the firms because lower CR spreads higher expected inflation means lower re interest rate okay now the the episode I describe you in in in in during the global financial crisis was exact opposite of this no in the global financial crisis we had this x boom jumping and I had shown you before that expected inflation came down a lot okay remember expected inflation came down a lot when negative no from around 2% to minus four that's a big shock for the real cost of borrowing for firms and the X went up like crazy that's the reason in the global financial crisis what we got is exactly the opposite of this we got a massive shift down in the zzer for the reasons we just described okay because this again this is the case for x going down or Pi going up in the global financial crisis we' got exactly the opposite and in massive amounts no massive increase in X massive decline in expected inflation so it's exact opposite of this and in a much larger scale that was a massive shock good so that's the case I was just describing that's what happened in the global financial crisis so the first thing is so if x goes up as it did in the global financial crisis and the Great Recession I I by the way when I say the global financial crisis or the Great Recession those are the same episode end up being it started from a financial crisis and it turned out ended up being a recession everywhere and a financial crisis everywhere as well okay but uh anyway so what I just described is this is the in the islm space the is is shifting inwards a lot no for any given nominal interest rate if x goes up a lot that means there is less investment and that means that the LM shift to the sorry the is shift to the left okay and the same would happen if there's a fallen expected inflation so for the great session we had two reasons why this thing move inward a lot one expected inflation came down and the other one X went up a lot massive movement to the left now what do you think a central bank should do face with a situation like this drop interest rate no why you you do that because this shocks enter like negative interest rate like shocks to the interest rate effectively it's like you had increased the interest rate a lot and so the central bank will try to offset that by lowering the interest rate what problem May the Central Bank face in doing this yeah reaching the zero lower bound effective lower one liquidity trap exactly it's a limit of how much you can do and I show you that that's what happened really here you see if effectively this is like it's the reason looks so flat it doesn't move is because it's against a lower bound it cannot move let me tell you a little bit about what is happening now so this is now remember the other one was for the period from 2008 to 2013 I show you now I'm shifting everything by 10 years okay so still you see on average the the the the white line which is the nominal interest rate is above the um the Orange Line the Orange Line the yellow line which is the um the real interest rate why is that yeah yeah posi inflation posit INF expected inflation but they're correlated when inflation is on average positive then expected inflation is also an average positive there's an exception there why is that what when does it happen there's one point where the real interest rate went above the nominal interest rate sorry recession yeah exactly the covid recession so as I said before that was a massive shock a scary shock and initial reaction of expected inflation was to come down enormously and that's so that's what we saw and also see that this biggest step here in the in the nominal interest rate and then flat so what do you think happened there yep again they went all the way down at to at the maximum they could do they said the the shortterm interest rate to zero effectively effect it's not exactly zero but to zero and they stay there for a very long period of time now why do you think and this I think help a lot the recovery of the US economy and it also a a a big reason for the rally that you saw in the equity Market in 2021 you can see in this picture which is this notice that the real interest rate went very very low you see that the real interest went very very low that's a reason Equity markets were flying I mean you have effectively very low real interest rates so what happened there how did that happened what must have happened in this episode yeah the central bank was putting injecting everything possible to it but even more than monetary policy conventional monetary but but what can prod what is the reason let me say this wedge reflects what what is the what is that W as a matter of accounting expected inflation yeah it's expected inflation so this tells you this interest was at zero the real interest was at at minus four here it means that expected inflation must have been 4% okay that means so we had a combination in which the nominal interest remain at zero but inflation was high which is not the typical combination we get in recessions like the previous one demand recessions financial crisis where inflation is goes down when you are in a recession this was a different shock and after the initial shock we got lots of bottlenecks on the supply side of the economy which we don't have a good mod yet later we want to have to model here and when you have prod in the supply side you can get a situation which it feels recessionary because there's low activity and so on but inflation is high and that's exactly what we had here okay the inflation was high now at some point H you know for a while we tolerated this inflation thinking that this was going to be a transitory phenomenon and so on but then it began to last for too long okay and when it began to last for too long then the the FED reacted and that's when you see they began to hike interest rate okay and they began to hike interest rate and that initially didn't do much er er to the real rates because expected inflation kept rising and then eventually they convinced everyone that they were serious about this and so real interest rate began to H rise a lot here and that's when the equity Market Collapse by the way you don't know that yet but I'm going to talk about Equity Market later on but but I believe me that's what essentially brought down the NASDAQ for sure primarily and all these M stocks and all that well that's that's that okay um what about today well Houston we have a problem because because you see the FED keeps Rising interest rate and inflation is not coming down as much as we expected in fact expected inflation initially looked like what's going to decline and and now it's beginning to pick up again so you have a situation here where the FED wants to be restrictive but the real interest is declining not going up that's a problem okay it's a problem that's that's what is happening at this very moment fed has a big problem because of that they're trying to tighten interest rate but Financial conditions are relaxing in a sense because of an increase in expected inflation and even credit spreads were declining like so here is what I just said in terms of inflation ER expected inflation and you see here the big collapse during covid early on in covid but then it recovered very strongly and went very high and and actually the middle of 2022 it really went up a lot and that's when the FED really got a scar and that's when they began to increase interest rate by 75 basis points in in a hurry okay and this is what you see recently I told you that we have a problem now because expected inflation they they were able there a famous conference Jackson happens in Jackson Hall ER and it's famous mostly because ER you know most Central chairs of presidents of central banks governors of central banks around the world sort of meet for a few days there but there is one speech that everyone looks at which is a speech of the of the um chair of the US Central Bank the FED okay and they were very worried that that conference happened around here and they were very worried because suspected inflation was just exploding I mean 6% or so that's those are unheard of numbers for the us since the 80s and and so they came up with a very tough speech very Hwy speech saying look this is unacceptable we're going to do whatever it takes to bring this stuff down and and and they were very successful persuading people in fact expected inflation began to decline a lot very quickly which is one of the reasons you see real rates Rising very fast in fact faster than than the nominal rates because nominal rates were rising and on top of that expected inflation began to plummet and that led to a very sharp rise in real interest rate and the collapse in the stock market as a result okay what about credit spreads in in this episode ER well here you see we had during the covid shock again we got a Bigg Spike here it was not as large as in in the other one which was a financial crisis per se but it was a very large Spike and then eventually sort of came down and it came down a lot that's again when you're seeing rallying and all the markets and so on H but then began to go up and and again here we began to a problem because the fair wanted to tighten and this credit spreads were coming down this got this is I think I did this on Sunday or something so today's 27 yeah I did it yesterday there it is okay so so this this pickup here is very recent this last week but great spreads were declining and that again goes against to to what the FED wants to do which is to tighten Financial conditions for firms okay now ER as I said before central banks typically intervene only the monetary policy they they involves very short duration treasury bonds so their own bonds okay the bonds of that government in most places like that but this shock was so disconcerting and so large and it did affect corporations a lot no because you get imagine you are in the irland industry and then suddenly you get covid so really was a a major shock to corporate to corporations and um so they went beyond traditional conventional monetary policy they certainly something that had done already in the global financial crisis they began to buy sort of very long duration US Treasury bonds so 10 year bonds and so on treasur but they went beyond that and they created a facility to buy corporate bonds okay that facility was meant to deal with XS okay you're getting a huge huge X shock and they went directly to that to try to bring that X shock down why do they want to do that well because of the reasons we have explained here H you know that amounted the X shock which came together with expected inflation coming down amount of big shift there they did all they could with conventional monetary policy they brought this down so you can think of their policies of intervention it's called they're called large scale asset purchases that's a generic number of that well what they were trying to do really is to act on those interest rates that do not show up in the LM that show up in here know x x is a parameter of here if I go out there and I buy a a corporate bonds then I'm reducing X which is a way of Shifting the yes back okay corporations can borrow more cheaply if the government is buying their bonds that's the whole idea in in in in Japan they even bought Equity okay the Equity interventions in the equity market so happened in Hong Kong in 1997 there was a massive intervention in the equity Market typically central banks don't do that but when situations get desperate and and you are against the zero lower bound so you you lost your conventional monetary tool ER they tend to be a little more creative and and that's what they've been doing okay any questions that's it for today from the yeah you have a question could you put X into like more tangible terms I think I'm still sort of like trying to figure out what a create spr for example a uh if if boing I don't think Bo is a high yield maybe maybe ER well let's say boing it's okay if boing borrows they're not going to be able to borrow the say that the 10e rate I'm showing it here in 10e rate spread the 10e rate the us at this moment is you know close to 4% if boing wants to borrow 10 years he's not going to be able to borrow at 4% they going to have to borrow at 7% so there's a 3% difference that's X that's X that's great SP spread which is linked to the perceived probability of the fault I said it's more than it's perceived when you say perceive is is the say the actual probability of theault who who knows who can measure that there are again agencies that try to meure measure them plus whatever extra risk premium you want to put on top of that Rel reliability of americ yeah how unattractive it looks to lend to a corporate versus lending to the US government and when this LM is very high it looks very unattractive to lend to corporations and therefore you need to be compensated a lot for that okay e