The worldwide change in the behavior of interest rates and prices in 1914: R. Barsky, G. Mankiw, J. Miron and D. Weil

Abstract

Short-term nominal interest rates in the United States and the UK experienced a structural change from stationary to nonstationary processes somewhere in the period 1914-1918. The most popular story thus far- based on switching-regression techniques-is that the founding of the Federal Reserve in November 1914 caused a simultaneous shift in both countries in early 1915. I use a recursive Bayesian method to show that this conclusion is flawed and the standard method lacks robustness. My results suggest a switch to nonstationary in late 1915 for the UK and in late 1917 for the United States related to the start of interest targeting in each country after entry into World War I and the consequent need for cheap finance of military expenditures.