TIME SERIES ANALYSIS OF INTEREST RATES: SOME ADDITIONAL EVIDENCE

Abstract

IN THE EARLY 1950's the Federal Reserve System pursued a bills only policy. That is, the System would conduct open market operations.only through the bill market with the effect on interest rates presumably being transmitted gradually to other sectors of the financial system.' This policy generated substantial research efforts. The thrust of subsequent theoretical and empirical arguments has evolved around the manner in which interest rate changes are transmitted from the bill market throughout the financial system. Since the mid-1960's, theorists and economic policy makers have been faced with a bewildering and conflicting array of empirical studies of interest rate relationships and behavior. Since the results of these studies are frequently incorporated into macro-economic models for forecasting and policy choice, it is important that the conflicts in the literature be thoroughly understood if not completely resolved. The purpose of this paper is to present the results of an analysis of the relationship between various interest rates. Specifically, the nature of the lead-lag relationship is examined as is the stability of the relationship over time. The generally accepted view is that long-term rates lag behind short-term rates. This view has, however, come under strong attack in recent years most notably by Cargill and Meyer [2], Pippenger [13], and Phillips and Pippenger [12]. The analysis herein, although employing a different analytical technique, provides strong additional support for these studies and is in sharp contrast to the earlier work of Modigliani and Sutch [8], [9]. The evidence indicates that there is no consistent and meaningful lead-lag relationship between long-term and short-term interest rates and that the bond market is efficient in that knowledge of past interest rates provides virtually no information regarding current rates. Furthermore, the analysis reveals that some of the statistically significant relationships that appear to be present are complex and unstable over time. In the following Section, we provide a brief overview of the conflicting literature. In Section III, we describe the analytical technique and its rationale. In Section IV, we present the results of the analysis and this is followed by a brief summary.