Can I Sign New Mexico Banking Word

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okay folks um good afternoon hopefully had a decent lunch um so before we get into talking some more about chapter 18 let's spend a few minutes talking about the exam on wednesday and then a little bit about the plan for tomorrow so first let me say a couple of words about the exam on wednesday because i know some of you might want to get a head start on getting ready for the exam tonight so what's going to be on the exam what's the setup going to be um the exam is going to be worth 130 points so it's going to be worth more points than your typical midterm which was worth 100 points of that 130 half of it is going to be a new material and half of it's going to be review okay so 65 points on new material 65 points on review material let's talk about the new material first it will cover basically just three chapters chapter 15 and 16 on monetary policy and inflation and chapter 18 on international macro so you can see there's actually not a ton of material to be covered on the new part of the exam and so i think this actually creates an opportunity to do well on this part of the exam there's not a great deal of new material to cover a lot of what we talked about in 15 and 16 is actually related to to what we talked about in terms of aggregate demand aggregate supply so you know really there's not a great deal of of like new stuff there so i really i do think that creates a possibility of doing well on the material on the new material and then these other 65 points of the exam is review okay so what will these this review part of the exam look like i basically sat down and kind of made a list of 10 12 things that i thought were really important concepts for you to get out of this class and then i'm going to ask you questions about eight or ten of them right so i mean that's basically how i did this so in terms of you know thinking about what you should study you want to focus on the big picture things that we've talked about throughout the block um for instance things relate to those big six questions that we talk about on the syllabus right um those are that you know i'm not really going to be focusing on like little nitpicky stuff that you know we talked about one time and then never came back to but it's really things that i think that we've come back to again and again that i really want to ask you questions about and so if it's important enough to show up on the final you can almost be assured that it's been important enough to show up on previous exams or previous quizzes and so i really think that a good way to study for the review part of this exam is well let me back up a not so great way to study for the review part of this exam is to go back and open up your notes and look at page one be like page one page two page three and just flip through all your pages that's not a particularly effective use of your time what i would do is i would go start by going back and looking at my exams and my quizzes seeing where i made things made mistakes or looking at things that maybe i didn't quite understand the first time and then maybe go back to that part of your notes right maybe spend a little bit of time looking over definitions and things like that particularly definitions that you've seen before on exams or quizzes so in other words do kind of a targeted review a targeted review that focuses on big things things that we've talked about before things that you've been asked about before so i think that's that is definitely going to be one of the things that that that's that's going to be the most productive way for you to spend your time studying for the review part of this i would say maybe one other thing that you can think about in terms of review is given that now it's kind of at the end of class this is an opportunity for me to ask you some class some questions that might pertain to the entire class from beginning to end right so not so much a question that's just pertaining to one you know one part of the class but but you know once again ideas or concepts that we've talked about throughout the class to ask you questions about that do not though spend all of your time thinking about or reviewing doing studying for the review part of the exam because remember that's only going to be half of this exam the other half is going to be the new material and so you know i i really do think that there is opportunities to do well on both parts of this exam right there's opportunity to do well on the review part because i think a lot of this should be familiar because we're going to really go back and hit a lot of topics that we've talked about before and there should be opportunity to do well in the new part because there's just not as much material and i don't think in general what we've talked about here over the last three or four days has been as complicated and so you know once again i think there's really an opportunity to do well on the final so does anybody have any questions about the final the structure i'll say one other thing about the final is that while it's worth 130 points and it will be longer in terms of more questions i don't really think it's going to be dramatically longer in terms of how much time it should take you so you know once again we'll plan on going from 9 to 11 30. that's been plenty of time for all of you up to this point or for most of you up to this point and so we'll we'll kind of essentially go go through the same thing i mean i guess now that i think about it i'll stretch it to him to noon so i'll give you until noon so i'll give you a little bit extra time but i i think for most of you this exam is not going to take a great deal more time than the midterms did okay so i don't you know i think there are some more questions but in in many ways i don't i don't think it's a it's going to be more time consuming exam my light is going out here okay so did anybody anybody have any questions about the the logistics the form what kind of to expect once again on on wednesday i'll expect everybody to be there in person unless you have unless you're taking the entire class off campus or you know unless you talk to me so i'll expect you all to be there in person hey todd uh do you have any any questions about the exam yes okay so uh that then what will be going on tomorrow tomorrow i will give you back your homework number five we'll go over that we'll finish up what we don't get through in chapter 18 and um then after that we will have some time for review in the morning okay so as i said this morning we um we we won't have i'm not planning on having afternoon class i'd prefer not to have afternoon class so my hope is that we can get bo we can get through chapter 18 and then we can also have time to review for the for the final exam tomorrow so max did you have a question [Music] yes um can you hear me i don't see no i can't hear you max can anyone else ah no i can hear you sorry sorry so i was wondering if you could give us like the keys for the previous test because i know if i was referring off my answers it would not help me for the final exam no and that's the reason why we went over the exams in class so if you do have questions you can either reach out to me individually or i've been recording those so you can go back and look over our discussion of the previously but that that's why i went over in the class all right i'll just go with the reviews okay anything else okay well without further ado let's get into the day now five minutes ago my ipad was working let's see if it's still working ah voila it is just you guys are getting sick and tired of me complaining about technology so i won't do it very much longer but you you just gotta let me vent for a second and say it's just inevitable it's just so perplexing to me why technology is working like when i go home and it works and i take it to cornell and it doesn't there's like some sort of like i don't know like like third or fifth or tenth dimension on cornell's campus that the crap doesn't work but okay there i got that off my chest now i'm ready to go so what are we going to talk about this afternoon um i want to spend a little bit of time talking about exchange rates this is really the last big topic in chapter 18 in many ways the last big topic of of uh this class is talk a little bit about exchange rates what are they where do they come from um that's this you know what determines exchange rates that's going to be kind of our focus this afternoon and then tomorrow we'll talk a little bit about the role of central banks in managing exchange rates so let's talk about exchange rates exchange rates are determined in what's called the foreign exchange market often referred to as the fx market this is the largest financial market in the world to give you some idea this is between 1 and 2 trillion dollars a day is traded in these financial markets minimum transactions in these foreign exchange markets are usually a minimum of a million dollars okay so these are huge financial markets where where is it located well it's not located anywhere right this is basically a network of um dealers right dealers often associated with major banks and other financial institutions that have departments in which people make trades most these trades are electronic right and so there's no physical location for this it's just a network of traders right who trade currencies and so that is what an exchange rate is right an exchange rate is just simply the price of one currency in terms of another currency right so for instance if we were talking about the dollar exchange rate what is the dollar exchange rate well there's multiple exchange rates but if we were doing it in terms of euros that would be one dollar exchange rate the number of euros you get per dollar right so the dollar exchange rate is basically the number of euros you get per dollar so right now i didn't look at this before class but this is something on the order of 0.9 so in other words you get 0.9 euros for every dollar roughly right roughly what's the euro exchange rate in dollars dollar over euro exactly it's dollar over euro which is one over point nine or one point one one right so these are just inverses of each other right these are just inverses of each other and in general you know newspapers will not report both of these they will report one of these expecting that you're smart enough to figure out what the other one is right in other words expecting you're smart enough to just take the inverse of it right what happens if and let me back up just to make sure we have some notation your book because we we typically are talking about the us case this your book will usually call this the xr right xr is the the dollar the price of the dollar in terms of another currency and so this would be one over xr okay now the most important thing to understand about exchange rate is it's just a price okay it is just a price there's really nothing particularly um distinct about exchange rates just like cars have prices and tables have prices currency has prices in terms of another currency and so really to understand exchange rates all you have to do is apply supply and demand right you can think about the foreign exchange market for let's let's say given we're talking about the us in general for dollars and you really have to think about this as a big market where there's a demand for dollars there's a supply of dollars and it's that supply and demand that determines the equilibrium exchange rate this is a market that is well described by a perfectly competitive framework right as i said there are a large number of buyers and sellers here right there's from all over the world people are buying and selling dollars there's a homogeneous good dollars run one dollar is the same as another dollar and everybody's a price taker because this market is so big there's really nobody that's big enough to really influence prices at least not directly and so this is really well described by just kind of a very simple supply and demand framework right it's just a very simple supply and demand framework and so what kind of things what kind of things influence the dollar exchange rate well two things things that shift the demand for dollars so let's talk about some of the things that shift the demand for dollars one of the things that shifts the demand for dollars is clearly interest rates interest rates in the us relative to other countries and the key here is this word relative because if interest rates go up in the u.s and interest rates go up everywhere in the world that's not going to change anything it's only when interest rates change in the u.s relative to other countries are you going to begin to see some movements in the value of the dollar so let's think about an example here let's say that interest rates rise in the u.s how's that going to impact the value of the dollar well it's going to change the demand for dollars does this make holding dollars more attractive or less attractive less i hear less i'm not writing it down what does that tell you no it makes it more attractive more attractive why because what can you do with that dollar now you could put it in a u.s bank you could put it in a u.s bond you could put it in any sort of interest bearing account and begin to earn a higher return on it so higher interest rates in the us are going to increase the demand for dollars and dollar assets that's the key right that's the key when when interest rates go up in the usa it actually makes the us a more attractive place to save it's a more attractive place so you're going to have capital inflows capital is one going to want to go into the united states where it can get a higher return so if this is the market for dollars what's going to happen the demand for dollars goes up and as a result the exchange rate goes up and using the lingo we usually call this an appreciation right the dollar appreciates so in this case when interest rates go up the dollar appreciates once again this is the same result you get if interest rates go down in the rest of the world because what matters is the relative interest rate okay so if interest rates go up in the u.s it's the same as if interest rates go down in the rest of the world or they go down in europe or they go down in canada right so the key to this is the relative interest rate right relative interest rate so one of the things that is followed extremely closely in foreign exchange markets is interest rates right interest rates um it's not number one but it's we're going to talk about what the number one thing is and that that drives movements in that in interest rates or drives movements and exchange rates but it is very closely followed right this is one of the big factors that determines interest rates and once again not just interest rates in the us but interest rates across the world are going to impact the value of the dollar right and so you know what happens anywhere in the world is going to have some impact on the value of the dollar because these are international markets something else that might impact the value of the dollar is just risk the risk of u.s assets for instance the recession in the us that's worse than in the rest of the world right what would this do to the value of the dollar well this is obviously an increase in risk right if the recession goes down buying a us bond or buying u.s assets they look riskier and so this is likely to reduce the demand for the dollar and if the demand for the dollar goes on goes down what's going to happen the dollar is going to depreciate what's happened to the dollar recently anybody know if it's been going up or down [Music] it's been going up right particularly strongly against european economies why probably the number one factor is that the u.s economy is doing better than the rest of the world that's not to say we're doing great but once again everything in this market is relative right it's relative to the rest of the world so while the u.s economy hasn't been doing great it's been doing better than europe and so the dollar is much stronger against most european currencies because of this right it's stronger against the british pound it's stronger against the euro a lot of that has been driven by risk that yes the u.s economy doesn't look o great but it looks a lot stronger than the european economy and the you and the u.s financial market look stronger than the european financial markets the third factor and by the way i want to be clear there's lots of different things that could impact exchange rates but i want to really focus on three right and so we've talked about interest rates we talked about risk but then there's a very important one and of all of them this is the one that's probably the most important and that is differences in interest rates i'm sorry differences in inflation rates differences in inflation rates between countries play a big role in what's happening to exchange rates [Music] okay so let's think about this when we've been talking about exchange rates what we've been talking about is essentially a nominal exchange rate right it's the price of one currency in terms of another currency but that really only gives us kind of a misleading picture about what's going on in terms of the price of actual goods because what's the problem with nominal exchange rates it's not adjusted for differences in inflation right if we're going to have a true picture of how much goods cost between countries we need to have some adjustment for the differences in the price level right differences in the price level you just can't go to europe and say oh that's a hundred euros um well and it's 90 in the us 100 is greater than 90 so i better buy it in the u.s that doesn't make any sense right you have to adjust for differences in the price level right you have to think about the real value of what that 100 euros can buy you versus the real value of what 90 dollars can buy you and so that's what we call a real exchange rate right and what a real exchange rate is is it's adjusted it's the exchange rate that's adjusted for differences in the price level okay it's adjusted for differences in the price level between countries how do you calculate the real exchange rate it's actually relatively simple you just take the nominal exchange rate and you adjust for the relative price level you adjust the nominal exchange rate to account for differences in the nut in the relative price level okay so think about this example okay let's say that you um you're interested in the real exchange rate between the u.s and mexico and so you go out there and you find that the nominal exchange rate meaning the number of pesos per dollar is equal to 19. okay so the current the current exchange rate is 19 pesos per dollar you go out and you look at the price level meaning some basket of goods like the consumer price index and you find that this basket of goods in the u.s costs a hundred dollars this same basket of goods in mexico costs 1400 pesos what's the real exchange rate the real exchange rate is the nominal exchange rate meaning 19 pesos per dollar divided by that ratio of prices in the u.s to prices in pesos notice here that these all cancel out right these units all cancel out and so what do you get 1900 divided by 1400 or what is that don't have my calculator on me anybody got a calculator there 19 divided by 1.35 1.35 that sounds right okay 1.35 what does this mean what this means is that goods in the u.s are more expensive if the real exchange rate is greater than one it means goods are in the us are more expensive and what would it mean if they were less than one well it would mean that goods in the u.s are cheaper than they are in mexico okay i don't know if any of you've ever traveled abroad hopefully you have if you've traveled abroad you've calculated real exchange rates you just have probably never called it a real exchange rate in your mind but you've calculated this in your head right if you go up to toronto on a weekend and you see a sweater in toronto and it's 80 canadian dollars what's the first thing you do you say well it's 80 canadian dollars so i need to convert that into u.s dollars which is 70 u.s dollars and then i think about well could i buy this same sweater for 70 bucks in the u.s if it would be more expensive than that in the us then i'll buy it in canada and if it's cheaper than that in canada then i'll buy it there right what you're doing is you're calculating a real exchange rate you've got you never called it that you didn't sit down with a piece of paper and calculate it but you that's essentially what you've done right you've compared the real cost of goods in canada to the real cost of goods in the us and that's all a real exchange rate is is it's really just a means of of comparing the price of one goods in one country or another right so for instance look at this um look at a little data here between the us and mexico this is looking at the exchange rate the light blue line is the nominal exchange rate over time so in other words over time you have to give more and more pesos per dollar over time you have to get more more pesos per dollar so the peso is depreciating versus the dollar over time here because you're getting more and more pesos per dollar but the dark blue line is the real exchange rate and notice how that's flat right notice how that's flat what does this tell us this tells us that why is the pace of depreciating against the dollar because the price level is changing at a different rate than the u.s price level right so when price levels between two countries change at different rates you're going to get changes in the nominal exchange rate in fact we can take this one step further and say they should change in a very predictable way and this is the concept of what economists call purchasing power parity the price of similar goods should be the same across not time sorry i don't know why i wrote that the price of similar goods should be the same across countries or else people will arbitrage um i don't know if you know what arbitrage means um arbitrage is just a fancy word for shop okay arbitrage is a fancy word for taking advantage of price differences and so people will take advantage of price differences if the price of similar goods are not the same between countries so you know just just to kind of think of a hypothetical example what happens if everything was cheaper in canada relative to the us what would people do they'd go up to canada buy goods and bring them back to the us but of course if everybody does that what's it going to begin to do to the exchange rate it's going to drive up the value of the canadian dollar drive down the value of the us dollar make canadian goods more expensive u.s goods cheaper and get rid of that price difference so the idea behind purchasing power parity is that in the long run prices between countries should be pretty much the same in other words what should be true about real exchange rates the real exchange rate should be one in the long run in other words the same good should in real terms be just exactly the same between countries and then remember if the real exchange rate is equal to one remember that's equal to the nominal exchange rate times the price level in the us divided by the price level in the foreign country or to flip this around what should determine what should be the primary thing that determines the nominal exchange rate differences in the price level differences in the price level should be the main thing that determines the nominal exchange rate that's the main thing that determines the nominal exchange rate is just differences in inflation so what happens if inflation's higher than mexico well use this formula if inflation's higher in mexico than it is in the u.s what's going to happen here to this ratio prices are going to go up a lot in mexico and a little bit in the u.s right and so what's going to happen to the nominal exchange rate for the u.s it will go up the dollar will appreciate the peso will depreciate if inflation is higher in mexico what's going to happen to the peso it's going to go down relative to the dollar that's the big thing that determines exchange rates that's the big thing differences in inflation so in other words what when we see a country that its currency tends to appreciate against other countries what does that mean it's a low inflation country right low inflation countries tend to see their currency appreciate low inflation countries tend to see their currency appreciate vice versa high inflation countries tend to see their currencies depreciate so this is this is a big insight into exchange rates i mean in fact this is the biggest insight if you if you need to know one thing about exchange rates and why they move that one thing is inflation in general the biggest thing that moves exchange rates is differences in inflation countries that have low inflation tend to see their currency appreciate countries that have high inflation tend to see and depreciate so for instance over the long term the dollar tends to appreciate against the peso right i think i just showed you some data here a figure or a figure that shows exactly this notice that there's you're getting more dollars per peso over time the dollar is appreciated why because inflation is higher in mexico than it is in the united states vice versa i don't have a graph for this but if you look at the the um dollar versus the japanese yen you see the opposite that the dollar tends to depreciate against the japanese yen why because japan has lower inflation in the us okay so just knowing that just knowing inflation rates you are going to know a lot about long run movements in the exchange rate does purchasing power parity hold in the real world that does is is it true that the price of similar goods are the same across countries well yes but but not perfect right here's looking at uh the canadian dollar versus the us dollar notice that you see the nominal exchange rate kind of moving all over the place but the blue exchange rate is the is the purchasing power parity exchange right basically the real exchange rate now is the real exchange rate equal to one no you notice that it's kind of close to 1.2 so it's close to one but it's not exactly one so you know how are you supposed to interpret that well you know purchasing power parity is a pretty good description of the world but it's not perfect and you know why isn't it perfect well it's per it's not perfect because in general you can't arbitrage quite as as nicely as this theory suggests so purchasing power parity holds roughly but it doesn't hold perfectly why well i i think maybe one way to think about this is purchasing power parity shouldn't just hold between countries it should hold within countries as well is there purchasing power parity between mount vernon and chicago do the price of similar goods are they the same in chicago as they are in mount vernon well for a lot of things they are right for a lot of things there are not big price differences between mount vernon chicago but for some things there's big price differences right what's what's the number one thing where there's a big price difference between mount vernon and chicago yes um there's a little yeah housing right housing is the big one right why not everything is tradable not everything is movable why is housing so much more expensive in mount in chicago because you can't really move land from chicago to mount vernon and vice versa right i mean if people could they would take land and move it to downtown chicago but you can't do that and so as a result it's not going to be subject to the to the um it's not going to be subject to the powers of purchasing power parity in other words arbitrage people shopping around and moving goods around is not going to be as effective somebody mentioned gas what why is gas i mean gas is not radically more expensive in chicago but it is more expensive why is gas more expensive in chicago biggest factor is taxes right that's the biggest factor between iowa and illinois is that iowa has much higher fuel taxes iowa actually has low taxes and we also subsidize our fuel through ethanol so iowa has cheap fuel largely because of government policy so the fact that there's government subsidies and taxes sometimes distorts purchasing power parity there's also another reason why gas is more expensive in in illinois um could people get around these taxes i'm sure you could go buy gas in iowa and take it back to illinois what's the problem with that like if you live in chicago what's the problem of driving to iowa to fill up your tank you like waste your tank on your drive back basically exactly right you're going to waste your in other words there's transaction costs particularly transportation costs that you have to think about so you know if everything was cheaper in canada that doesn't mean that i'm going to drive up to canada to do my grocery shopping because it's just still not going to be worth my time and so as a result you've got to think about and then then other times there's just barriers between countries there's just you can't simply move goods because of there's there's no there's no trade agreement between countries so so for instance you wouldn't expect purchasing power parity to hold very well between the us and north korea because there's lots of barriers of moving goods between the u.s and north korea so purchasing power parity is not you have to think about this as like a rough approximation of the world right it you know having said that you know being an economist right and i'm kind of an avid traveler so you know as i've traveled around i've you know i pay attention to these kind of things right so it's always interesting to me to kind of think about like a can of coke and to pay attention to what a can of coke costs and interestingly enough pretty much wherever you go in the world it doesn't cost that much difference in botswana or in nepal as it does in the us so for goods that can be moved around pretty easily that don't have high taxes that don't have huge transport costs or there's trade barriers yeah purchasing power parity is a pretty good description of the world the key though to understanding purchasing power parity is what it says about inflation right because it tells us why inflation is the number really the number it's the third thing we talked about but it's the number one thing that influences exchange rates right differences in inflation differences in inflation differences of risk and differences in interest rates those are the three big things that drive the demand for dollars and drive exchange rate movements right those are the three things there's also a fourth thing this is something that shifts the supply of dollars and this is monetary policy monetary policy is the number one thing that that shifts the supply of dollars and let's talk about this tomorrow right so we're not going to get into this this afternoon but this is really where we're going to pick up tomorrow and talk about right given we've talked about things that shift the demand for dollars now let's talk about things that shift the supply particularly monetary policy before before i let you go um i just do want to talk about just one last thing and this is just kind of a way that people talk about exchange rates that i think we should we should think about there's definitely this perception in the public in the news that a strong dollar is good for the us right when the dollar appreciates we celebrate and when the dollar depreciates i then you know that's we feel bad about it is that the way that we should respond to hearing that the dollar has appreciated or depreciated absolutely not because what does it mean when the dollar appreciates well it doesn't really mean much in the sense that yes it's good for some people and it's bad for other people but that doesn't mean that it really has any meaning outside of that right what happens when the dollar appreciates well what does that do it makes us exports more expensive when the dollar appreciates now you have you're getting fewer dollars for foreign currency it makes u.s exports more expensive it tends to hurt u.s exports vice versa it tends to make u.s imports cheaper and so they increase u.s imports it tends to make us assets more valuable but then it tends to hurt americans that own foreign assets so here's the point i'm trying to make is an appreciation of the dollar a good thing depends who you are it depends w o you are it's a good thing and a bad thing it's it's neither it's neither have you ever been seen anybody go to the grocery store and say wow the price of the apples is really strong yeah price of apples is strong that's good for us that's good for the country no you never hear anybody say that because why would you think that it matters that the price of apples is strong it's not strong prices go up or they go down that's the same with you have to the same way you have to think about the exchange rates right the price of the dollar goes up it goes down it's not strong or weak in the sense that when people use the word strong or weak it's like they're talking about our national manhood right we want a strong manhood or we're having a weak right personhood that's ridiculous way to think about it right prices go up prices go down you have to think about exchange rates in the same way so a higher exchange rate of the dollar an appreciation of the dollar is neither all good nor all bad it depends who you are right in many cases a depreciation of the dollar is quite welcome because a depreciation of a dollar if you turn this around it tends to make u.s exports cheaper it tends to help u.s exports so people in export industry actually prefer what you could call a weaker dollar right they would prefer a lower dollar the main thing i don't want us to fall into is this trap of thinking that somehow it's good if the dollar always goes up in value or it's bad if the dollar always goes down in value no it's it's neither good nor bad it's just a price right and when prices go up that helps some people and hurts other people and when prices go down it helps some people and hurts other people right so it should never be the goal of monetary policy or the goal of exchange rate policy to you know make your currency strong or to make it weak and when you hear policy makers or politicians talking that way um it really tells you they don't really quite understand what they're talking about quite honestly again [Laughter] and so uh you know not to keep on mentioning a guy's name and to pick on one party but you know it's hard not to talk about him um donald trump the last four years had a lot of spent a lot of time talking about how he wanted a strong dollar well first off i don't know what a strong dollar means but the idea that he thought you could have a strong dollar but also reduce the trade deficit well that doesn't make much sense right because what's a strong dollar going to do a strong dollar is going to decrease u.s exports and increase imports and weaken our trade deficit worsen our trade deficit so you know the fact that that he and other politicians talk about wanting to have a strong dollar on one hand but wanting to reduce the trade deficit on the other hand once again they don't understand those two concepts don't go together right they don't go together and so you know just be wary right if you hear somebody talking about a strong dollar a week dollar um you know oftentimes that's just kind of a they're kind of just using buzzwords without really quite understanding everything that goes into this okay so i think that's probably a pretty good way a pretty good point to stop so the main thing we want to talk about tomorrow is to talk about how central banks can manage exchange rates right how central banks can manage exchange rates so i think we probably have about an hour's worth of material to cover tomorrow and so as i said we will cover that material in the morning and then we'll spend the rest of afternoon class um just kind of an opportunity for you to ask questions or anything else about the exam so okay we all good with that okay well if so have a good afternoon and uh see you back 9 00 am tomorrow morning have a good one