An Empirical Inquiry Into the Variation of Interest Rates, 1959-1983 (Time Series Analysis, Spectral, Money Supply, Inflation Rate).

Abstract

The empirical relationships among nominal interest rates, the inflation rate, and the money supply are examined for the period, 1959-1983. Monthly data are analyzed. The analysis of these relations specifically focuses on (1) the determination of the causal order between the variables and (2) the estimation of empirical lag distributions. The Gibson test, the Granger test, the Box-Jenkins test, and the Haugh test are used for these purposes. In addition, vector autoregressive-moving average models are estimated to determine how the variables are correlated. Finally, spectral analysis is used to determine the periodic movements of interest rates and to test if there are significant correlations with the inflation rate and the money supply along these periodic movements. Empirical results suggest a positive response of nominal interest rates to changes in the money supply and the inflation rate. The estimated lags do not exceed one quarter in both cases. There is also a significant positive feedback from nominal interest rates to the money supply in both the short and long-run and a negative feedback from nominal interest rates to the money supply in the short-run. The statistical evidence suggests a very quick adjustment of bond markets to innovations in money and commodity markets. This evidence casts doubt on the Fisher approach which emphasizes the importance of past inflation rates in determination of current interest rates. The overall picture implies a response of interest rates to all kinds of information and not only to the information contained in the inflation rate series. This fact points out the highly efficient information processing character of the bond market. Multivariate analysis further confirms this point by showing that the variables are related to each other through the innovation series and unsystematic information is utilized in the assessment of nominal interest rates. In frequency domain, spectral analysis indicates a significant correlation between nominal interest rates and the inflation rate at the high frequency band. There is no significant correlation between the nominal interest rate and the inflation rate along the business cycles. There is, on the other hand, spectral evidence of a correlation between the money supply and interest rates along a nine-month cycle and minor business cycles. This last point suggests that the periodic movements of interest rates may be closely related to the stabilization policies pursued by the Federal Reserve.