Instructor: Common Trends and Cycles in U.S.

Interest Rates

As a junior financial analyst in an investment bank, you have been assigned to

investigate the dynamics of some key U.S. interest rates. These interest rates are
expected to be related for several reasons. According, for example, to the
expectations and liquidity premium hypotheses of the term structure of interest
rates, short and long rates move together over time. Moreover, according to the risk
structure of interest rates, interest rates on corporate bonds are always higher than
interest rates on government bonds with the same term to maturity. Go to
www.stls.frb.org, click on FRED, and then on Interest Rates to access historical U.S.
interest rate data. Although some series go as far back as 1919, you decide to analyze
U.S. interest rate movements in the period after 1955, thereby ignoring the effects of
certain big shocks to the U.S. economy such as, for example, the Great Depression
and World War II.

1. Get monthly data, from January 1955 to February 2002, on the federal funds rate, the
one-year Treasury bill rate, a 10-year interest rate, and interest rates on AAA and
BAA corporate bonds.
• Present a time series plot of these interest rate series and comment on their
long-run co movements.
• Calculate the mean and standard deviation as well as the maximum and
minimum values for each series over the sample period (from January 1955
to February 2002). Which were the worst and best years in terms of interest
rates?
2. One interesting feature of this data set is the contemporaneous correlation between
the different series. Calculate the contemporaneous correlations between these
interest rate series.
• Which series exhibit the strongest correlations? The weakest? Do the
correlation patterns you identified here manifest in the graphical
representation of the series?
• Compare the contemporaneous correlations over the whole period with those
in the 1960's, 1970's, 1980's, and 1990's.
3. Present a time series plot of the spread between the interest rates on each of AAA and
BAA corporate bonds and the Treasury bill rate.
• Do these spread series show evidence of a trend?
• Calculate the mean and standard deviation as well as the maximum and
minimum values for each of the spread series.
4. It has been argued in the text that interest rates are procyclical (that is, they tend to
be high when the level of economic activity is high and low when the level of
economic activity is low).
• Describe how you would investigate the cyclical properties of interest rates
and interest rate spreads.
• Are risk premiums on corporate bonds procyclical or countercyclical? Why?
 Students: Online Information, Statistical Techniques, and
Policy Analysis: Case Study

As a junior financial analyst in a brokerage firm, you have been asked by your boss to
demonstrate the usefulness of the World Wide Web as a convenient resource for
financial research. You have also been asked to answer a number of questions about
the general conduct of monetary policy in the United States. As an incentive, you are
given one week of paid holidays to the Greek islands in the Aegean Sea.

One popular source of U.S. data is the Federal Reserve Economic Database (FRED),
maintained by the Federal Reserve Bank of St. Louis. Go to www.stls.frb.org to access
the site and locate historical data on a number of key macroeconomic variables. Your
objective is to use the World Wide Web to transfer information via the Internet, to
use statistical graphics and analysis to process the information, and to compare the
macroeconomic performance in the United States in the 1990s with three other
recent decades -- the 1960s, 1970s, and 1980s.

1. Get monthly data, from January 1960 to December 1999, on core CPI
(Consumer Price Index) to compare the inflation performance in the United
States in the 1990s with other recent decades, such as the 1960s, 1970s, and
1980s. In particular,
• Calculate the inflation rate over the entire period and present a time
series plot of the series (that is, graph the inflation rate series against
time).
• Calculate the average inflation rate and its standard deviation over each
of the last four decades, and comment on the level and variability of
inflation over time.
• Which were the worst and best decades in terms of inflation?
2.Another aspect of macroeconomic performance (beyond inflation
performance) is growth in real GDP. Find an annual real GDP (chained in
1996 dollars) series in FRED and calculate the annual real GDP growth rate
over the period from 1960 to 1999.
• Graph the real growth rate of the economy.
• Present summary statistics for each of the last four decades on the
average real growth rate and its volatility.
• Which decade had the slowest real growth? The highest?
• Which decade had the most stable economic growth?
3.It would be an oversight to neglect the money supply and the role of monetary
policy. Get monthly data, from January 1960 to December 1999, on the M1
measure of the money supply (a commonly used measure of the money
supply).
• Calculate and graph the money growth rate.
• Which decade had the slowest money growth? The highest?
• Which decade had the lowest money growth volatility? The highest?
• Compare the average inflation rate and the average money growth rate
over each of the four decades. Is the evidence consistent with the
proposition of the quantity theory of money that slower money growth
implies lower inflation?