Macroeconomic Report
How Interest Rate Affects U.S. Economy
November 29th, 2014
Yingxi Lu
Bin Luo
Jiachen Zong
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Content
I. Introduction
Statement of the Thesis
Statement of the Problem/Issues
II. Hypothesis
III. Literature Review
Relationship between Interest Rates and Aggregate Demand
Describe How Expansionary Monetary Policy Is Used to Affect Interest Rates
IV. Methodology
Relationship between Low/High Interest and Economic Growth in the U.S
Economic Recession
Economic Expansion
General Effects of Interest Rates
Examine the Effects of Interest Rate on Exchange Rates
Examine the Effects of Interest Rate on Net Exports
V. Conclusion
VI. Endnotes
VII. Appendices
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Chart & Table
Chart 1. Relationship between Output and Price Level
Chart 2. LM Curve and IS Curve
Chart 3. Prime Rate, Consumption, Investment, and Real GDP
Chart 4. 10-year Treasury Bond Yield, Government Spending, and Real GDP
Chart 5. Interest Rates and Unemployment Rate
Chart 6. Interest Rates and Unemployment Rate (1-year Lag Adjusted)
Chart 7. Changes among Federal Funds Rate, Prime Rate, and Exchange Rate
Table 1. Linear Regression Results
Table 2. Interest Rate Changes in Expansion
Table 3. Economic Growth in Expansion
Table 4. Interest Rate Changes in Recession
Table 5. Economic Growth in Recession
Table 6. Exports and Imports of Goods and Services by Type of Product ($billions)
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I. Introduction
Statement of the Thesis
An analysis of vivid relationships among interest rate, exchange rate and determinants of GDP
such as private consumption, domestic investment and net export reveals the entire performance
of American economy. Through considering each individual determinant of GDP along the
variations of interest, the thorough depicted explanations will interpret the constructive
relationships and offer valuable recommendations upon the current American economic status.
Statement of the Problem/Issues
We believe that this analysis will provide audience with a comprehensive understanding of the
economic relationship between interest rate and real GDP, what are the causes and effects that
can help explain the changes in the economic environment and correspond the suspicions of how
economists are able to control the national business operation. Of course we need to explore how
strong the relationship between them and what economic outcome may be associated with each
specific fact. The research will interpret the definition of fed fund rate and prime rate, then
exemplifying the relationship between interest rates and aggregate demand in general, next,
describing how expansionary Monetary policy is used to affect interest rates, afterwards,
providing time series data illustrating the relationship between low/high interest and economic
growth in the U.S, finally, examining the affects of interest rate on exchange rates and net
exports.
II. Hypothesis
Before conducting any academic analysis and thorough proof by persuasive data and evidences,
we assume that the interest rate initiatively affects the real GDP throughout different periods of
time. The interest rate is the most dominant factor influencing the trend of real GDP indirectly.
However, there are some intermediary causes derived from the changes in interest rate. Those
products at some level may indirectly drive the real GDP up and down. By further research from
literature review, statistical analysis and data collations, we will be able to prove the assumption
on the basis of macroeconomic point of view.
III. Literature Review
Relationship between Interest Rates and Aggregate Demand
To explain the relationship between interest rates and aggregate demand, we begin with defining
interest rates and aggregate demand. The interest rate is the annual rate at which interest is paid;
a percentage of the borrowed amount (McConnell and Brue, 2009). And the interest rates include
thousands of, if not hundreds of rates like nominal interests, real interests, which have been
thoroughly instructed at class, federal funds rate, and prime interest rate, etc. In this article, we
will concentrate on their relationship in general. And aggregate demand is a schedule or curve
that shows the amount of a nation’s output (real GDP) that buyers collectively desire to purchase
at each possible price level (McConnell and Brue, 2009).
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Chart 1. Relationship between Output and Price Level
The graph above vividly shows the negative effect, and nearly a negative linear correlation, that
interest rate has on Aggregate demand. To be specific, the downward slope of the aggregate
demand curve is the interest-rate effect ， Keynesian theory. Also known, as the quantity of
money demanded is dependent up the price level. A high price level means that it takes a large
amount of currency to satisfice the purchasing demand. As a result, consumers demand large
amount of currency when the price level is high and vice versa. When the supply of loans
increases, the cost of loans and the interest rate decrease. Thus, a low price level leads an
inducement to save and an increase in demand for investment, as the cost of investment falls
with the interest rate. In a nutshell, a drop in the price level decreases the interest rate, then
increases the demand for investment and thus increases aggregate demand (Williams R., 1972).
Chart 2. LM Curve and IS Curve
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There is another major model, IS-LM model (Roy Harrod et al., 1936) that is useful for
explaining the relationship between the interest rate and aggregate demand. The IS curve
describes the equilibrium in the market for goods and services where Y = C(Y - T) + I(r) + G.
And the LM curve describes equilibrium in the money market where M/P = L(r,Y). The IS-LM
model exists in a plane with Y, being both income and output, on the horizontal axis and r, the
interest rate, on the vertical axis and.
The IS curve describes equilibrium in the market for goods and services in terms of r and Y.
The IS curve is downward sloping, because when the interest rate falls, investment increases,
leads to an increasing output. And the LM curve describes equilibrium in the market for money.
Opposite to the IS curve, the LM curve is upward sloping because higher income results in
higher demand for money, thus resulting in higher interest rates. And the intersection of the IS
curve with the LM curve shows the equilibrium interest rate and price level （Keynesian
theory,1930).
By using the IS-LM model the aggregate demand curve can be driven. One way to draw the
downward sloping aggregate demand curve from the IS-LM model depends on the effects of an
increase in the price level on output or income.
When the price level increases, the LM curve shifts inward. The inward shift in the LM curve
results in an intersection of the IS-LM model at a lower level of output and income and a higher
interest rate. In general, from the IS-LM model, it is clear that aggregate demand is directly and
negatively related to interest rate.
Describe How Expansionary Monetary Policy Is Used to Affect Interest Rates.
Monetary policy is a central bank’s changing of the money supply to influence interest rates and
assist the economy in achieving price-level stability, full employment, and economic growth
(McConnell and Brue, 2009). And it contains of expansionary monetary policy and restrictive
monetary policy. The goal of expansionary policy is to decrease unemployment rate, expand
business and stimulate GDP, majorly by increasing the overall money supply. To increase the
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money supply, the following action will be taken: (1) buy government securities from banks and
the public in the open market, (2) lower the discount rate, (3), lower the legal reserve ratio and (4)
reduce the interest rate that it pays on reserves. The outcome will be an increase in excess
reserves in the commercial banking system and a decline in the federal funds rate, thus a decline
in the interest rate in general. As excess reserves are the basis on which commercial banks and
thrifts can earn profit by lending and creating checkable-deposit money, the nation’s money
supply will rise. An increase in the money supply will lower the interest rate, increasing
investment, aggregate demand, and equilibrium GDP. In a nutshell, an expansionary monetary
policy (loose money policy) increases the commercial bank reserve rate, then, changes in
reserves decreases the money supply, and such change in the money supply will rise the interest
rate. To go one step further, as the increased interest rate will have a negative effect on
investment, and as the investment, a part of the aggregate demand, decrease, the aggregate
demand will decrease.
IV. Methodology
Relationship between Low/High Interest and Economic Growth in the U.S
In this part, we illustrate the relationship between interest rate and US economic growth by
analyzing original data collected from 1957 to 2013. In terms of interest rate, we focus on 2
types of rates, prime interest rate and 10-year Treasury Bond yield. 10-year Treasury Bond yield
usually is considered as the cost of government’s borrowings, and it affects government spending
substantially. Prime interest rate is a major reference point for banks to determine interest rates
charged on loans to businesses and individuals. It incurs direct impact on private consumption
and domestic investment. However, we also introduce federal funds rate. Federal funds rate is
regarded as a benchmark rate, powerfully influencing various interest rates in an economy.
Since a country’s economy is affected by various factors, interest rate is not a sole contributor to
any change in economic growth. In a certain period of time, an economic impact of interest rate
may be weighed much less than other factors’. Vietnam War, from 1957 to 1968, real GDP of
United State was driven by expansive fiscal policy, conducting massive spending on military,
while both prime interest rate and 10-year Treasury Bond yield showed an upward trend. Prime
interest increased from around 4% to 6.31%, and 10-year Treasury Bond yield rose from 4% to
5.64%. During 1973 to 1978, the economy suffered a recession and a stagflation due to a
quadrupling of oil prices by OPEC. Recession in 1991 resulted from a combination of the
subsequent oil price shock, the debt accumulation of the 1980s, and growing consumer
pessimism. From 2005 to 2007, with a boom in real estates industry, the country’s economy kept
its pace on expansion. However, interest rate during that period of time presented an upward
trend.
In order to distinguish effects caused by interest rate from those incurred by other factors, we
removed data of some years. Based on our research, we found and kept data from several
valuable periods of time. We took into account two recessions due to an increase in interest rate.
One happened in late 1969. The other occurred in late 1979, followed by the early 1980s
recession. Economy expansions from 1971 to 1972, from 1983 to 1990, from 1992 to 2001, from
2002 to 2004, and from 2010 to 2013 were mainly caused by a decrease in interest rate. Besides,
a prompt downward adjustment on interest rate did effectively alleviate the recession during
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2008 and 2009. Total years we examined are 33 years (lists of data are shown in appendices,
from Table 2. to Table 5.).
Economic Recession
1969 – 1970
Conducting an expansionary fiscal policy towards Vietnam War, the government hugely
increased its military spending. Total government expenditure experienced a double-digit growth
from 1966 to 1968. Meanwhile, such great demand for money borrowing had pushed up interest
rate by 1969 to a relatively high level, in which 10-year Treasury Bond yield was 6.67%,
increasing by 18.3% from 5.64% yield in 1968, and it peaked at 7.35% in 1970. The stimulation
also triggered an increasing inflation.
Faced with a high cost of borrowing, the government slowed down its spending growth to around
7%. Attempting to control inflation, the Fed took manipulation. In 1969, both federal funds rate
and prime interest rate reached their historical peaks, which were 8.21% and 7.96% respectively.
An increasing cost of borrowing means a higher required rate of return. Consequently, in 1970,
with domestic investment reduced by 2% and growth of private consumption slowed down to
2.3%, real GDP rose only by 0.2%. Due to a lag, unemployment rate went up to 6% in 1971,
compared to 3.6% in 1968 prior to the recession.
1979 – 1982
To fight against the inflation of the 1970s, under Paul Volcker, Chairman of Federal Reserve, the
Fed dramatically pushed up interest rates. Federal funds rate rocketed to 16.39% in 1981 from
7.94% in 1978, and prime interest rate soared to 18.87% in 1981 from 9.06% in 1978. Higher
interest rate severely obstructed private spending. Private consumption had an average growth at
mere 1%, and both domestic investment and real GDP experienced a decline in 1980 and 1982.
2008 – 2009
The great recession in this period is called Subprime mortgage crisis. Before the crisis, financial
institutions were willing to loan low-credit people to purchase houses. They also securitized the
mortgage and trade tremendous Mortgage-Backed Securities. When numbers of people defaulted
on the mortgage, the capital chain of financial institutions was going to collapse. The Fed reacted
immediately. It largely bought back Mortgage-Backed Securities, supplying huge amount of
money to back up financial institutions. Federal funds rate as a result dropped sharply by 61.75%
and 91.67% in 2008 and 2009 respectively. Banks with more excess reserves were willing to
loan cheaply to businesses and individuals. The prime interest rate was cut more than one-third
in each year. 10-year Treasury Bond yield was down to 3.26% from 4.63% in 2007, and
government spending expanded. With those efforts, though domestic investment nearly shrank
by a quarter and unemployment rate almost doubled, the Fed limited the loss in private
consumption (-0.6% in 2008 and -1.9% in 2009) and lowered the degree of a decline in real GDP
(-0.3% in 2008 and -2.8% in 2009).
Economic Expansion
1971 – 1972
After a brief recession during 1969 and 1970, the Fed stimulated the economy right away.
Federal funds rate was cut more one-third, and prime interest rate reacted by falling nearly 30%
as well. A sharp drop in prime interest doubled the growth of private consumption to 6.1% in
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1972, while growth in investment spurred 15% both in these two years. Government spending
was encouraged by a 1% reduce in 10-year Treasury Bond yield. Since three-fourths of its
components increased noticeably, the real GDP rose more than 3% annually as a result.
1983 –1990
During this period, oil price was favorably low. To seize the opportunity, the Fed successfully
applied its expansionary monetary policy. Federal funds rate decreased five times in 8 years as
well as prime interest rate. Abundant money supply set a downward pressure on 10-year
Treasury Bond yield, which was down to 8.55% in 1990, compared to 13.92% during the early
1980s recession. Private consumption, domestic investment, and government spending all
increased at a constantly rapid rate. The unemployment rate decreased from 9.6% at the
beginning of the period to 5.6% at the end. In conclusion, the economy enjoyed the second
longest peacetime economic expansion in US history.
1992 – 2001
The longest period of economic expansion, exactly 10 years, happened during 1992 and 2001.
The main reason of the growth in this period must be attributed to the development of the IT
industry. In these 10 years with more stimulation than in the previous 8 years, federal funds rate
was kept at an even lower level, around 5%. Consequently, the average prime interest rate
dropped by nearly 2%. Same pattern showed on 10-year Treasury Bond yield. The yield kept
going down to 5.02% from 8.55% in 1991. The outcome was eminent. After a 10-year growth, in
2001 private consumption ($7.6 trillion), domestic investment ($1.9 trillion), and total
government spending ($3.2 trillion) were 147%, 194%, and 171%, respectively, as much as their
counterparts in 1990. Unemployment rate dropped down to 4.7% in 2001 from 7.5% in 1992.
2002 – 2004
In this period of time, the economy was accelerated by the booming real estates industry. The
greatest stimulus was reduction in 10-year Treasury Bond yield. Treasury Bond yield received a
substantial decrease by 15% from 2002 to 2004. The lower the yield, the lower the mortgage rate.
Thus, people were attracted to invest in housing. Besides, persuaded by the Department of
Housing and Urban Development, the government, taking advantage of lower cost of borrowing,
encouraged companies to participate in the development of real estates industry by giving out
subsidies. In this period, investment was the main factors pushing up real GDP.
2010 – 2013
In this period, the economy suffered a phenomenon called liquidity trap. Though the Fed
provided plenty money supply and manipulated federal funds rate close to zero, banks, which
feared about credit risks, were unwilling to loan out their excess reserves carelessly, and did not
want to lower their required rate of return. A noticeable fact was that the prime rate was
unchanged, instead of decreasing, stable at 3.25%. Under a depressed economic situation
resulting from the Subprime mortgage crisis in 2008, it seemed there was less guarantee to repay
loan with interest in a short period of time. Thus, short-term loan suffered, which led to a low
growth in private consumption, around 2 %. Meanwhile, financial institutions still wanted to gain,
therefore selecting and giving loan to high quality investment projects. In this case, domestic
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investment had a delightful performance. It grew by 11.9%, 6.6%, 10.7%, and 6.8% from 2010
to 2013 respectively. Since investment creates occupation, unemployment rate gradually ended
up to 5.9% from 9.3% in 2009, and real GDP grew at a steady pace, around 2% annually.
General Effects of Interest Rates
There are two interest rates, prime interest rate and 10-year Treasury Bond yield, we mainly
focus on. We first conclude effects of prime interest rate. Prime interest rate is directly relevant
to borrowing from businesses and individuals. An increase in prime interest rate refers to a
higher cost of borrowing and will reduce private consumption and domestic investment. Since
consumption and investment together compose a large proportion of real GDP, real GDP will
decrease as well. A decrease in prime interest rate causes an opposite effect. Although prime
interest rate and the economy both experienced a decline during 2008 and 2009, as we already
discussed, a declining prime interest rate helps the economy limit its losses in recession. As
shown in the line chart below, despite some fluctuation, prime interest rate has an opposite
movement against those three economic indicators. Besides, absolute values of correlation
coefficients between prime interest rate and each of those three are all greater than 0.5 (shown as
Table 1, Page 10). Thus, prime interest rate has a strong negative correlation with private
consumption, domestic investment, and real GDP.
Chart 3. Prime Rate, Consumption, Investment, and Real GDP
20.00
real gdp(trillion)
15.00
private
consumption(trillion
adjusted 2005)
domestic
investment(nominal
trillion)
prime rate %
10.00
5.00
2013
2011
2009
2004
2002
1998
1996
1994
1992
1989
1987
1985
1983
1981
1979
1971
1969
0.00
(Data in1973—1978, 1991, 2005—2007 is not included)
10-year Treasury Bond is an usual tool for the government to borrow money from the market.
The yield of the bond is the cost of borrowing. Therefore, a lower yield will encourage
government borrowing. The more the government borrows, the more it spends. Besides,
government spending can expand real GDP by its multiplier effect. Thus, a lower yield of the
bond can increase real GDP. Though on the line chart below, there is some deviation from the
theoretical relationship, as an overall process, the yield of 10-year Treasury Bond moves
reversely against real GDP and government spending. Based on Table 1. (Page 10), 10-year
Treasury Bond yield has a strong negative correlation with government spending (r = -0.59 <-0.5)
and a moderate negative correlation with real GDP growth (r = -0.46 > -0.5).
Chart 4. 10-year Treasury Bond Yield, Government Spending, and Real GDP
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20.00
15.00
real gdp(trillion)
10.00
Total government
spending (trillion
nominal
5.00
10yr Tbond %
2013
2011
2009
2004
2002
1998
1996
1994
1992
1989
1987
1985
1983
1981
1979
1971
1969
0.00
(Data in1973—1978, 1991, 2005—2007 is not included)
The relationship between interest rates and unemployment rate is not apparent. However, we can
find a nearly one-year lag effect on unemployment rate, according to the Chart 5. The adjusted
chart is shown as Chart 6. One main discrepancy is the data of the period during 2008 and 2009.
The reason why a negative relationship shows up is that the Subprime Mortgage Crisis was so
severe that even a substantial decrease in interest rate was not enough to stimulate an economy
recovery. Since the economy declined, the number of people unemployed may increase.
However, based on Table 1. (page 10), the absolute value of correlation coefficient with
unemployment rate for prime interest rate and that for 10-year Treasury Bond yield are both less
than 0.2. We consider that the correlation between interest rates and unemployment rate is
neutral.
Chart 5. Interest Rates and Unemployment Rate
20.0
15.0
unemployment(%)
10.0
prime rate %
5.0
10yr Tbond %
2013
2011
2009
2004
2002
1998
1996
1994
1992
1989
1987
1985
1983
1981
1979
1971
1969
0.0
(Data in1973—1978, 1991, 2005—2007 is not included)
Chart 6. Interest Rates and Unemployment Rate (1-year Lag Adjusted)
10
20.0
15.0
unemploymen
t(%)
10.0
prime rate %
5.0
10yr Tbond %
0.0
(Data in1973—1978, 1991, 2005—2007 is not included)
Table 1. Linear Regression Results
IV
Slope
IV
Slope
IV
Slope
IV
Slope
IV
Slope
IV
Slope
IV
Slope
Prime Interest Rate
-0.60
Prime Interest Rate
-0.37
Prime Interest Rate
-0.12
Prime Interest Rate
0.08
10-yr Treasury Bond Yield
-0.49
10-yr Treasury Bond Yield
-0.33
10-yr Treasury Bond Yield
-0.03
DV
r-square
DV
r-square
DV
r-square
DV
r-square
DV
r-square
DV
r-square
DV
r-square
Real GDP ($trillion)
0.43
r
-0.66
Private Consumption ($trillion)
0.42
r
-0.65
Domestic Investment ($trillion)
0.39
r
-0.62
Unemployment (1-year Lag Adjusted)
0.04
r
0.19
Real GDP ($trillion)
0.21
r
-0.46
Government Spending ($trillion)
0.34
r
-0.59
Unemployment (1-year Lag Adjusted)
0.01
r
-0.07
(The number of years examined is 33. Data in1973—1978, 1991, 2005—2007 is not included)
Examine the Effects of Interest Rate on Exchange Rates
This part will be discussing the relationship between interest rate and exchange rate, the interest
rate is a board term which can be extended on multi-functional basis in monetary institutions. As
previously mentioned the some major types of interest rate, fed fund rate, Treasury bond rate and
prime interest rate all play vital roles in the monetary demand and supply market. However, they
function differently based on the type of institution, what we aim to discover is the relationship
between prime interest rate and exchange rate, the reason why we pick on the prime interest rate
is because the rate is directly related to the agreements where the cost of borrowing is set
between money lenders and borrowers. On the other side, the exchange rate will be also affected
by the monetary demand and supply. Exchange rate can be recognized as three significances,
constant exchange rate means determinants altogether don’t have net effect on the exchange rate.
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However, if the exchange rate goes up, this implies that the currency in terms of dollars will
appreciate towards foreign currencies; simply, the dollar is more valuable today than before in
the money market. On the contrary, if the exchange rate falls, this motion signals that the
currency in terms of dollars will depreciate towards to foreign currencies, apparently a dollar is
worth less than before.
In order to have sufficient observations on the data series and have explanatory result by
demonstrating evidence, we have collected history evidences from federal official website that
related what we want to analyze in this paper. Despite some data were present in a complex
manner or not representative enough to illustrate the key influences. Lacking of time frequencies
of correlated data will need further inference of possible situations back on the timeline. As the
methodology approaches, we input the possibly relevant data series into the graph and inspected
the movements on each data series, then, based on the year in which the data series arrived, we
measure the discrepancies and identify the relationship among them. After all, we characterize
the entire graph as a complete analysis of dynamic relationship.
Chart 7. Changes among Federal Funds Rate, Prime Rate, and Exchange Rate
We introduced the descriptive statistics of yearly value for all three variables, as the table shows,
the three variables, exchange rate, prime rate and fed rate were present since 1999 due to the
limited resource available. Vertical axis represents both exchange rate for dollars in terms of
euro and interest rate of money market transactions. Clearly, the movement of prime rate mimics
the fed rate at which roughly 3% gap below the prime, due to the supply and demand effect of
the amount of money, commercial banks can borrow at lower rate than public customers. The
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prime rate tends to be constant after the big recession in 2008, however, the exchange rate
fluctuated slightly around 1.3. this action may be explained by other factors which were
determinants of exchange rate. McConnell and Brue (2009) in the macroeconomic verified that
Inflation, taste, relative income or speculation were all considered to be the influential force that
can impact the variability of exchange rate. Back in the recession, the skyrocketed prime rate
started in late 2004 and reached at peak in 2007, suddenly, the interest rate adjusted by
decreasing 5% to rescue the economy. During this period, the rapid growths leaded the exchange
rate bound up and drop accordingly with immediate reaction after the peak, it is certain to say
that interest rate is positively related with exchange rate. A sequence of scenario will help to
clarify the confusions, if interest rate rises, the expected return will increase, and foreign
investors are more likely put their money in US market to earn higher return. In fact, the high
demand on US dollars will shift the demand curve rightward, and then increase the equilibrium
exchange rate corresponding to the interest rate. In the previous cycle started in early 1999, it
showed the same logics on the relationship between the interest rate and exchange rate.
Examine the Effects of Interest Rate on Net Exports
Inevitably, people may connect the topics of exchange rate with net exports. Indeed, these two
subjects are all taken account into the foreign markets. Practically speaking, the exchange rate
and net exports are tightly related with each other. We will examine the close relationship on the
statistical platform; net export provides a sense of how a nation performs their business activities
globally, in another word, the performance is measured as the amount contributed to national
total GDP. If the net exports are positive, it means that the total exports exceed total imports, the
positive value will be added into total GDP calculation, in contrast, if the net exports are negative,
the opposite situation will apply as well. Our goal is to investigate the volatility of net exports as
the changes in interest rates.
Unlike the method of assessing the relationship between interest rate and exchange rate, this
analysis will focus on the wide range of data along the timeline. Those data were acquired from
federal official website of Saint Louis region with the reputation built in among databases. Two
tables attached in the report are indications of exports and imports of goods and services within
last night years in billions, one accounts for the inflation in which the data of year 2009 was set
as standard pole among others, the other one was recorded under nominal activities without of
consideration of inflation. The data distinctly echoed the events taken place in the past and offer
a great insight on the fluctuations of international trades. In detail, it also provides the subcategories of each major products and services that are frequently transacting in the global
market. The portion of individual sector was clearly disclosed in the table. Connecting the two
tables with the previous line chart will allow us to tackle the exact amount of exports and imports
for each year along the changes of interest rate. Then detecting the movements of variables will
enclose the point of relationship between interest rate and net exports.
By tracking the amount of change from previous period, we can tell that the big recession took
the severe response in 2009 on both imports and exports, even though the net exports don’t seem
drop a lot, instead rise about 400 billion, the United States still suffered economic pressure on
rapid growth. In 2010, the policy drives interest rates descend in order to accommodate the
unstable international trades. This conduct smoothed the net exports back on the normal level
and doesn’t change quite a lot since the interest rate tends to be constant for last few years. In
general, the relationship between interest rate and either exports or imports is positively
correlated, however, the fact of net exports is inclined to react inversely with interest rate. The
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reason behind the data may be included some other factors such as international trade policies,
the procedures of shipments and change in taste of foreign goods and services. For the purpose
of fully interpreting that relationship, a further step needs to be conducted thoroughly by
analyzing all the determinants of net exports, for the main goal, we established the substantial
outcome that net exports will be inversely related with interest rate.
V. Conclusion
This paper basically addresses issues in the structures of business world to adequately model and
describe the dynamics of interest rate influence, even though some discoveries maybe familiar to
the readers about the elementary level of understanding, we try to correctly explain and interpret
in a sophisticated and uncomplicated approach to convey our perspectives and share our
comprehensions about macroeconomic at our best interest. The analytic studies regarding the
relationships between the interest rate, monetary policy, economic growth, exchange rate and net
exports tend to result in a chain relation, while testing the joint movements from all different
variables; we notify the patterns of co-movements from each subtopic have some significant
turning points that result either in notable elevations or extraordinary downfalls. Not surprisingly,
those phenomenons can be well determined by historical events and rationales that
macroeconomic concepts are able to referred.
In particular, the interest rate falls with the subsequent outward shift in demand, then the
aggregate demand will rise, the relationship between them is negative. An expansionary
monetary will release the money supply and increase the reserve rate, then eventually, the
interest rate will pursue the track of reserve rate. In addition, prime interest rate indicates a strong
negative correlation with private consumption, domestic investment, and real GDP. Moreover,
10-year Treasury bond yield has a strong negative correlation with government spending (r = 0.59 < -0.5) and a moderate negative correlation with real GDP growth (r = -0.46 > -0.5). Further,
the correlation between interest rates and unemployment rate is neutral. Regarding international
challenge, interest rate is more likely to pave the road in the same direction for exchange rate.
Whereas the net exports proceeds the converse path distinguished from the exchange rate.
In short, we are very proud of our fantastic collaboration and we have done such a
comprehensive research on the interest, by going through all the resources, we have gained
tremendous experience in the macroeconomic field, yet, due to the accessibility of resource and
database, we didn’t spend our time sufficiently exploring valuable references and expert opinions,
also, our perspectives were restricted by our educational background. As for the picture of
American economy, we propose that don’t rush to the ultimate object hastily with the immediate
changes of executions over the certain controllable mechanisms. Be patient and insightful over
the course of considerations, take full account into the decision making process and efficiently
explain the most feasible implementation.
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VI. Endnotes
Barron J, Lynch G, (1987). The Aggregate Demand Curve: A Defense. Journal Of Economic
Education [serial online].18(1):41-46. Available from: Business Source Premier, Ipswich, MA.
Accessed November 23, 2014.
Board of Governors of the Federal Reserve System. 2014. “Selected Interest Rate and Historical
Data”. Accessed November 22, 2014
http://www.federalreserve.gov/releases/h15/data.htm
Bureau of Labor Statistics. 2014. “Databases, Tables & Calculators by Subject” Accessed
November 23, 2014
http://data.bls.gov/pdq/SurveyOutputServlet
Bureau of Economic Analysis. 2014. “National Economic Accounts” Accessed November 23,
2014
http://www.bea.gov/national/index.htm
Christopher Chantrill. 2014.“Multiyear Download of US Government Spending 1960-2014”.
Accessed November 22, 2014
http://www.usgovernmentspending.com/download_multi_year_1960_2014USb_16s2li001mcn_
F1t
Economic Research. 2014.“Interest Rates”. Accessed November 22, 2014
http://research.stlouisfed.org/fred2/categories/22
McConnell and Brue,(2009). Macroeconomics.
Roy Harrod, John R. Hicks, and James Meade, (1936)
Tobin J. A, (1969). General Equilibrium Approach To Monetary Theory. Journal Of Money,
Credit & Banking (Ohio State University Press) [serial online].
Williams R, (1972). Nominal interest rates and aggregate demand: an empirical, study of the
post-war period. Journal Of Finance[serial online27(5):1182.
15
VII. Appendices
Table 1. Linear Regression Results
IV
Prime Interest Rate
DV
Real GDP ($trillion)
Slope
-0.60
r-square
0.43
r
-0.66
IV
Prime Interest Rate
DV
Private Consumption ($trillion)
Slope
-0.37
r-square
0.42
r
-0.65
IV
Prime Interest Rate
DV
Domestic Investment ($trillion)
Slope
-0.12
r-square
0.39
r
-0.62
IV
Prime Interest Rate
DV
Unemployment (1-year Lag Adjusted)
Slope
0.08
r-square
0.04
r
0.19
IV
10-yr Treasury Bond Yield
DV
Real GDP ($trillion)
Slope
-0.49
r-square
0.21
r
-0.46
IV
10-yr Treasury Bond Yield
DV
Government Spending ($trillion)
Slope
-0.33
r-square
0.34
r
-0.59
IV
10-yr Treasury Bond Yield
DV
Unemployment (1-year Lag Adjusted)
Slope
-0.03
r-square
0.01
r
-0.07
(The number of years examined is 33. Data in1973—1978, 1991, 2005—2007 is not included)
Table 2. Interest Rate Changes in Expansion
Federal Funds Rate Prime INT Rate 10yr T-Bond Yield
Year
(%)
(%)
(%)
1971 -- 1972
1970
7.17
7.91
7.35
Changes
-34.87 %
-27.56 %
-16.19 %
1971
4.67
5.73
6.16
Changes
-4.93 %
-8.38 %
0.81 %
1972
4.44
5.25
6.21
1983 -- 1990
1982
12.24
14.85
13.01
Changes
-25.74 %
-27.34 %
-14.68%
1983
9.09
10.79
11.10
Changes
12.54 %
11.58 %
12.25%
1984
10.23
12.04
12.46
Changes
-20.82 %
-17.52 %
-14.77%
1985
8.10
9.93
10.62
Changes
-16.05 %
-16.11 %
-27.78%
1986
6.80
8.33
7.67
Changes
-2.06 %
-1.44 %
9.39%
1987
6.66
8.21
8.39
5yr T-Bond Yield
(%)
7.38
-18.83 %
5.99
-0.17 %
5.98
13.01
-17.06 %
10.79
13.62 %
12.26
-17.46 %
10.12
-27.87 %
7.30
8.77 %
7.94
16
Changes
1988
Changes
1989
Changes
1990
13.66 %
7.57
21.66 %
9.21
-12.05 %
8.10
1991
Changes
1992
Changes
1993
Changes
1994
Changes
1995
Changes
1996
Changes
1997
Changes
1998
Changes
1999
Changes
2000
Changes
2001
Changes
2002
Changes
2003
Changes
2004
5.69
-38.14%
3.52
-14.20%
3.02
39.40%
4.21
38.48%
5.83
-9.09%
5.30
3.02%
5.46
-2.01%
5.35
-7.10%
4.97
25.55%
6.24
-37.82%
3.88
-56.96%
1.67
-32.34%
1.13
19.47%
1.35
2009
Changes
2010
Changes
2011
Changes
2012
Changes
2013
0.16
12.50 %
0.18
-44.44 %
0.10
40.00 %
0.14
-21.43 %
0.11
13.52 %
9.32
16.63 %
10.87
-7.91 %
10.01
1992 -- 2004
8.46
-26.12%
6.25
-4.00%
6.00
19.17%
7.15
23.50%
8.83
-6.34%
8.27
2.06%
8.44
-1.07%
8.35
-4.19%
8.00
15.38%
9.23
-25.14%
6.91
-32.42%
4.67
-11.78%
4.12
5.34%
4.34
2010 -- 2012
3.25
0%
3.25
0%
3.25
0%
3.25
0%
3.25
5.48%
8.85
-4.07%
8.49
0.71%
8.55
6.80 %
8.48
0.24 %
8.50
-1.53 %
8.37
7.86
-10.81%
7.01
-16.26%
5.87
20.78%
7.09
-7.33%
6.57
-1.98%
6.44
-1.40%
6.35
-17.17%
5.26
7.41%
5.65
6.73%
6.03
-16.75%
5.02
-8.17%
4.61
-13.02%
4.01
6.48%
4.27
7.37
-16.01%
6.19
-16.96%
5.14
30.16%
6.69
-4.63%
6.38
-3.13%
6.18
0.65%
6.22
-17.20%
5.15
7.77%
5.55
10.99%
6.16
-25.97%
4.56
-16.23%
3.82
-22.25%
2.97
15.49%
3.43
3.26
-1.23%
3.22
-13.66%
2.78
-35.25%
1.80
30.56%
2.35
2.20
-12.27 %
1.93
-21.24 %
1.52
-50.00 %
0.76
53.95 %
1.17
17
Table 3. Economic Growth in Expansion
Real GDP
Private
Domestic
Year
($ Billion) Consumpti 1971
Investment
-- 1972
on
(Nominal
1970
4722.00
2740.20
170.10 $
($
Billion
Billion)
Changes
3.30%
3.81%
15.70%
Adjusted
1971
4877.60
2844.60
196.80
2005)
Changes
5.20%
6.15%
15.96%
1972
5134.30
3019.50
228.20
1983 -- 1990
1982
6491.30
3876.70
581.00
Changes
4.60%
5.72%
9.72%
1983
6792.00
4098.30
637.50
Changes
7.30%
5.30%
28.64%
1984
7285.00
4315.60
820.10
Changes
4.20%
5.21%
1.17%
1985
7593.80
4540.40
829.70
Changes
3.50%
4.05%
2.35%
1986
7860.50
4724.50
849.20
Changes
3.50%
3.09%
5.06%
1987
8132.60
4870.30
892.20
Changes
4.20%
4.03%
5.02%
1988
8474.50
5066.60
937.00
Changes
3.70%
2.83%
6.69%
1989
8786.40
5209.90
999.70
Changes
1.90%
2.04%
-0.62%
1990
8955.00
5316.20
993.50
1992 -- 2004
1991
8948.40
5324.20
944.40
Changes
3.60%
3.41%
7.26%
1992
9266.60
5505.70
1013.00
Changes
2.70%
3.55%
9.26%
1993
9521.00
5701.20
1106.80
Changes
4.00%
3.82%
13.53%
1994
9905.40
5918.90
1256.50
Changes
2.70%
2.70%
4.85%
1995
10174.80
6079.00
1317.50
Changes
3.80%
3.49%
8.70%
1996
10561.00
6291.20
1432.10
Changes
4.50%
3.69%
11.42%
1997
11034.90
6523.40
1595.60
Changes
4.50%
5.24%
8.76%
1998
11525.90
6865.50
1735.30
Changes
4.70%
5.42%
8.58%
1999
12065.90
7237.70
1884.20
Changes
4.10%
5.07%
7.94%
Total
Government
Spending
296.09
(Nominal
10.24% $
Billion)
321.84
9.43%
354.79
Unemployme
nt (%)
4.98
19.40%
5.95
-5.88%
5.60
1073.12
8.83%
1179.43
5.47%
1283.58
10.52%
1353.81
6.44%
1496.29
4.35%
1592.72
6.58%
1662.02
7.52%
1771.33
9.68%
1904.54
9.71
-1.12%
9.60
-21.79%
7.51
-4.22%
7.19
-2.67%
7.00
-11.79%
6.18
-11.07%
5.49
-4.25%
5.26
6.81%
5.62
2088.85
5.51%
2230.30
3.21%
2353.13
3.53%
2428.59
5.04%
2514.26
3.33%
2640.93
3.57%
2728.78
3.83%
2826.20
4.26%
2934.49
6.22%
6.85
9.37%
7.49
-7.79%
6.91
-11.70%
6.10
-8.33%
5.59
-3.28%
5.41
-8.63%
4.94
-8.94%
4.50
-6.30%
4.22
-5.93%
18
2000
Changes
2001
Changes
2002
Changes
2003
Changes
2004
12559.70
1.00%
12682.20
1.80%
12908.80
2.80%
13271.10
3.80%
13773.50
7604.60
2.71%
7810.40
2.66%
8018.30
2.82%
8244.50
3.29%
8515.80
2009
Changes
2010
Changes
2011
Changes
2012
Changes
2013
14418.70
2.50%
14783.80
1.60%
15020.60
2.30%
15369.20
2.20%
15710.30
9032.60
1.81%
9196.20
2.53%
9428.80
1.85%
9603.30
N/A
N/A
2033.80
-5.17%
1928.60
-0.19%
1925.00
5.35%
2028.00
12.26%
2276.70
2010 -- 2012
1878.10
11.86%
2100.80
6.62%
2239.90
10.68%
2479.20
6.81%
2648.00
3059.39
5.86%
3249.60
7.83%
3439.99
6.20%
3709.39
5.38%
3939.44
3.97
19.54%
4.74
21.97%
5.78
3.60%
5.99
-7.51%
5.54
5360.08
-0.13%
5974.77
3.27%
5967.28
-0.20%
6162.33
-1.11%
6150.02
9.28
3.68%
9.63
-7.19%
8.93
-9.61%
8.08
-8.98%
7.35
Table 4. Interest Rate Changes in Recession
Year
Federal Funds Rate Prime INT Rate 10yr T-Bond Yield
1969 -- 1970
(%)
(%)
(%)
1968
5.66
6.31
5.64
Chang
45.05%
26.15%
18.26%
es
1969
8.21
7.96
6.67
Chang
-12.67
-0.63
10.19
es
1970
7.17%
7.91%
7.35%
1979 -- 1982
1978
7.94
9.06
8.41
Chang
41.06%
39.85%
12.13%
es
1979
11.2
12.67
9.43
Chang
19.20%
20.44%
21.21%
es
1980
13.35
15.26
11.43
Chang
22.77%
23.66%
21.78%
es
1981
16.39
18.87
13.92
Chang
-25.32%
-21.30%
-6.54%
es
1982
12.24
14.85
13.01
2008 -- 2009
2007
5.02
8.05
4.63
Chang
-61.75%
-36.77%
-20.95%
es
2008
1.92
5.09
3.66
Chang
-91.67%
-36.15%
-10.93%
es
2009
0.16
3.25
3.26
5yr T-Bond Yield
(%)
5.70
21.58%
6.93
6.49
7.38%
8.32
14.30%
9.51
20.40%
11.45
24.45%
14.25
-8.70%
13.01
4.43
-36.79%
2.8
-21.43%
2.2
19
Table 5. Economic Growth in Recession
Real
Private
Domestic
GDP
Consumptio
Investment
Year
($
n
(Nominal $
Billion)
($ Billion
Billion)
1969 -- 1970
Adjusted
1968
4569
2580.7
156.9
2005)
Chang
3.10%
3.75%
10.64%
es
1969
4712.5
2677.4
173.6
Chang
0.20%
2.35%
-2.02%
es
1970
4722
2740.2
170.1
1979 -- 1982
1978
6267.2
3691.8
478.4
Chang
3.20%
2.38%
12.81%
es
1979
6466.2
3779.5
539.7
Chang -0.20%
-0.35%
-1.78%
es
1980
6450.4
3766.2
530.1
Chang
2.60%
1.52%
19.07%
es
1981
6617.7
3823.3
631.2
Chang -1.90%
1.40%
-7.95%
es
1982
6491.3
3876.7
581
2008 -- 2009
2007
14873.7
9262.9
2643.7
Chang -0.30%
-0.55%
-8.28%
es
2008
14830.4
9211.7
2424.8
Chang -2.80%
-1.94%
-22.55%
es
2009
14418.7
9032.6
1878.1
Total Government
Spending (Nominal $
Billion)
Unemployme
nt (%)
248.07
6.82%
277.19
8.70%
296.09
3.56
-1.87%
3.49
42.72%
4.98
668.17
9.82%
734.47
16.57%
806.57
14.13%
940.24
9.91%
1073.12
6.07
-3.57%
5.85
22.65%
7.18
6.16%
7.62
27.46%
9.71
4720.89
8.33%
4948.04
11.47%
5360.08
4.62
25.63%
5.8
60.06%
9.28
20
Table 6. Exports and Imports of Goods and Services by Type of Product ($billions)
Consumer goods, except food
447.6 479.8 485.7 429.9 485.1 515.9 518.8 533.9
and automotive
Other
87.2
88.8
86.5
80
93.1
97.1
102.6 106.1
347.6 379.4 415.6 392.9 415.2 441.6 456.4 468.1
Imports of services 1
Transport
78
79.3
84
64.1
74.6
81.4
85
90.8
Travel (for all purposes
84.2
89.2
92.5
81.4
86.6
89.7
100.3 104.7
including education)
Charges for the use of
25
26.5
29.6
31.3
32.6
36.1
39.5
39
intellectual property n.e.c.
Other business services 3
126.6 149.3 174
178.5 183.6 197.3 197.7 202.3
Government goods and
27.4
28.3
28.9
31.5
32
31.3
27.9
25.3
services n.e.c.
Other
6.4
6.8
6.6
6.1
5.9
5.9
6.1
6
Addenda:
Exports of durable goods
715
782.9 829.2 671.6 801.4
894
940.9 957.3
Exports of nondurable goods
334.6 383.5 469.6 393.5 478.2 572.9 586.2 605.5
Exports of agricultural goods
72.9
92.1
118
101
119
140
145
148.3
4
Exports of nonagricultural
1074. 1180.
1160. 1326.
976.7
964.1
1382.2 1414.6
goods
3
8
6
8
1176.
1106. 1238.
Imports of durable goods
1131.2
1163 893.8
1328.7 1360.5
2
9
7
Imports of nondurable goods
768.5 827.5 986.4 696.5 842.9 1006 977.4 941.7
Imports of nonpetroleum
1657. 1673. 1322. 1596. 1782.
1583
1871.7 1914.6
goods
1
3
6
2
6
Table 7. Real Exports and Imports of Goods and Services by Type of Product,
21
Chained Dollars (billions)
2006
Exports of goods and
services
Exports of goods 1
Foods, feeds, and
beverages
Industrial supplies and
materials
Capital goods, except
automotive
Automotive vehicles,
engines, and parts
Consumer goods,
except food and
automotive
Other 3
Exports of services 1
Transport
Travel (for all
purposes including
education)
Charges for the use of
intellectual property
n.e.c.
Other business
services 4
Government goods
and services n.e.c.
Other
Residual
Imports of goods and
services
Imports of goods 1
Foods, feeds, and
beverages
Industrial supplies and
materials, except
petroleum and
products
Petroleum and
products
Capital goods, except
automotive
Automotive vehicles,
2007
2008
2009
2010
2011
2012
2013
1506.8 1646.4 1740.8 1587.7 1776.6 1898.3 1960.1 2019.8
1062
1141.5 1211.5 1065.1 1218.3 1297.6 1344.9 1382.9
84.8
92.2
98.4
93.9
103.6
103.3
102.3
104.5
270
284.5
315.6
293.5
339.4
361.5
367.5
382.5
399.3
431.8
457.7
391.5
445.1
487.2
515.8
519.3
110.4
123.4
122.3
81.7
111.5
130.1
140.5
145.8
134.8
149.3
161.5
149.3
163.1
170.5
174.1
183.1
66.4
443.5
60.3
65.1
504.1
65.8
59.2
528.3
68.7
55.2
522.6
62.2
55.6
558
65.9
46.8
600.6
67.7
49.8
614.7
68.8
51.7
636.6
72.3
111.5
121.5
130.3
119.9
132.9
139.2
144.6
153.9
88.6
100.7
101.9
98.4
105.9
118.5
118.5
120.5
153.8
185.9
199.5
210.9
224.3
241.3
249.1
256.3
20.1
21.3
18.2
19.8
18.4
22.1
22.2
22.3
9.2
-2.9
9
-4.6
9.5
-2.2
11.4
-0.1
10.6
-0.1
12.3
-2.9
11.9
-4.6
11.3
-2.4
2301
2359
2298.6 1983.2 2235.4 2357.7 2412.6 2440.3
1925.4 1960.9 1887.9 1590.3 1826.7 1932.1 1973.1 1991.5
87.8
88.9
87.9
82.9
84.8
86.4
89.6
93.1
292.3
280.9
260.1
196.6
225.3
239.6
245.5
249.5
309
301.7
291.3
267.7
269
263.9
242.5
225.1
414.9
442.9
450.1
374.1
453.8
516.2
553.6
565.1
267.1
267.1
235.5
159.2
224.2
245.8
281.4
292.7
22
engines, and parts
Consumer goods,
except food and
automotive
Other
Imports of services 1
Transport
Travel (for all
purposes including
education)
Charges for the use of
intellectual property
n.e.c.
Other business
services 4
Government goods
and services n.e.c.
Other
Residual
463.2
489.9
484
429.9
485.4
507.4
502.9
518.6
95
370.5
79.5
95.1
393.5
80.8
84.5
408.2
77.6
80
392.9
64.1
90.5
407.8
68.3
91
424.2
70.5
95.3
438.7
72.5
98.4
448.4
76.8
93.9
91.9
89.5
81.4
84.8
85.5
95.4
98
26.6
27.3
29.6
31.3
32.1
34.7
37.3
36.4
131.5
156.3
176.9
178.5
184.2
197.9
199.5
206.7
31.6
29.2
27.8
31.5
32.5
30.2
28
24.5
6.6
1
6.9
-0.9
6.3
-3.1
6.1
0
5.8
-5.5
5.6
-16.7
5.6
-36.1
5.5
-49.3
23