Macroeconomic ReportHow Interest Rate Affects U.S. Economy

November 29th, 2014

Yingxi Lu

Bin Luo

Jiachen Zong

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Content 3I. Introduction 3Statement of the Thesis 3Statement of the Problem/Issues 3II. Hypothesis 3III. Literature Review 3Relationship between Interest Rates and Aggregate Demand 3Describe How Expansionary Monetary Policy Is Used to Affect Interest Rates 5IV. Methodology 6Relationship between Low/High Interest and Economic Growth in the U.S 6Economic Recession 6Economic Expansion 7General Effects of Interest Rates 8Examine the Effects of Interest Rate on Exchange Rates 11Examine the Effects of Interest Rate on Net Exports 12V. Conclusion 13VI. Endnotes 15VII. Appendices 16

Chart & TableChart 1. Relationship between Output and Price LevelChart 2. LM Curve and IS CurveChart 3. Prime Rate, Consumption, Investment, and Real GDPChart 4. 10-year Treasury Bond Yield, Government Spending, and Real GDPChart 5. Interest Rates and Unemployment RateChart 6. Interest Rates and Unemployment Rate (1-year Lag Adjusted)

Chart 7. Changes among Federal Funds Rate, Prime Rate, and Exchange RateTable 1. Linear Regression ResultsTable 2. Interest Rate Changes in ExpansionTable 3. Economic Growth in ExpansionTable 4. Interest Rate Changes in RecessionTable 5. Economic Growth in RecessionTable 6. Exports and Imports of Goods and Services by Type of Product ($billions)

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I. Introduction

Statement of the ThesisAn 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/IssuesWe 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 DemandTo 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. MethodologyRelationship between Low/High Interest and Economic Growth in the U.SIn 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 Recession1969 – 1970Conducting 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 – 1982To 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 – 2009The 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 Expansion1971 – 1972After 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 –1990During 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 – 2001The 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 – 2004In 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 – 2013In 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,

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domestic 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 RatesThere 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

0.002.004.006.008.00

10.0012.0014.0016.0018.0020.00

real gdp(trillion)

private consump-tion(trillion adjusted 2005)

domestic investment(nominal tril-lion)

prime rate %

(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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0.002.004.006.008.00

10.0012.0014.0016.0018.00

real gdp(trillion)

Total government spending (trillion nominal

10yr Tbond %

(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

19691971

19791981

19831985

19871989

19921994

19961998

20022004

20092011

20130.02.04.06.08.0

10.012.014.016.018.020.0

unemployment(%) prime rate %10yr Tbond %

(Data in1973—1978, 1991, 2005—2007 is not included)

Chart 6. Interest Rates and Unemployment Rate (1-year Lag Adjusted)

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0.02.04.06.08.0

10.012.014.016.018.020.0

unem-ployment(%)

prime rate %

10yr Tbond %

(Data in1973—1978, 1991, 2005—2007 is not included)

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)

Examine the Effects of Interest Rate on Exchange RatesThis 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 ExportsInevitably, 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 sub-categories 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, 2014http://www.federalreserve.gov/releases/h15/data.htm

Bureau of Labor Statistics. 2014. “Databases, Tables & Calculators by Subject” Accessed November 23, 2014http://data.bls.gov/pdq/SurveyOutputServlet

Bureau of Economic Analysis. 2014. “National Economic Accounts” Accessed November 23, 2014http://www.bea.gov/national/index.htm

Christopher Chantrill. 2014.“Multiyear Download of US Government Spending 1960-2014”. Accessed November 22, 2014http://www.usgovernmentspending.com/download_multi_year_1960_2014USb_16s2li001mcn_F1t

Economic Research. 2014.“Interest Rates”. Accessed November 22, 2014http://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.

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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 ExpansionYear Federal Funds Rate

(%)Prime INT Rate

(%)10yr T-Bond Yield

(%)5yr T-Bond Yield

(%)1971 -- 19721970 7.17 7.91 7.35 7.38

Changes -34.87 % -27.56 % -16.19 % -18.83 %1971 4.67 5.73 6.16 5.99

Changes -4.93 % -8.38 % 0.81 % -0.17 %1972 4.44 5.25 6.21 5.98

1983 -- 19901982 12.24 14.85 13.01 13.01

Changes -25.74 % -27.34 % -14.68% -17.06 %1983 9.09 10.79 11.10 10.79

Changes 12.54 % 11.58 % 12.25% 13.62 %1984 10.23 12.04 12.46 12.26

Changes -20.82 % -17.52 % -14.77% -17.46 %1985 8.10 9.93 10.62 10.12

Changes -16.05 % -16.11 % -27.78% -27.87 %1986 6.80 8.33 7.67 7.30

Changes -2.06 % -1.44 % 9.39% 8.77 %1987 6.66 8.21 8.39 7.94

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Changes 13.66 % 13.52 % 5.48% 6.80 %1988 7.57 9.32 8.85 8.48

Changes 21.66 % 16.63 % -4.07% 0.24 %1989 9.21 10.87 8.49 8.50

Changes -12.05 % -7.91 % 0.71% -1.53 %1990 8.10 10.01 8.55 8.37

1992 -- 20041991 5.69 8.46 7.86 7.37

Changes -38.14% -26.12% -10.81% -16.01%1992 3.52 6.25 7.01 6.19

Changes -14.20% -4.00% -16.26% -16.96%1993 3.02 6.00 5.87 5.14

Changes 39.40% 19.17% 20.78% 30.16%1994 4.21 7.15 7.09 6.69

Changes 38.48% 23.50% -7.33% -4.63%1995 5.83 8.83 6.57 6.38

Changes -9.09% -6.34% -1.98% -3.13%1996 5.30 8.27 6.44 6.18

Changes 3.02% 2.06% -1.40% 0.65%1997 5.46 8.44 6.35 6.22

Changes -2.01% -1.07% -17.17% -17.20%1998 5.35 8.35 5.26 5.15

Changes -7.10% -4.19% 7.41% 7.77%1999 4.97 8.00 5.65 5.55

Changes 25.55% 15.38% 6.73% 10.99%2000 6.24 9.23 6.03 6.16

Changes -37.82% -25.14% -16.75% -25.97%2001 3.88 6.91 5.02 4.56

Changes -56.96% -32.42% -8.17% -16.23%2002 1.67 4.67 4.61 3.82

Changes -32.34% -11.78% -13.02% -22.25%2003 1.13 4.12 4.01 2.97

Changes 19.47% 5.34% 6.48% 15.49%2004 1.35 4.34 4.27 3.43

2010 -- 2012 2009 0.16 3.25 3.26 2.20

Changes 12.50 % 0% -1.23% -12.27 %2010 0.18 3.25 3.22 1.93

Changes -44.44 % 0 % -13.66% -21.24 %2011 0.10 3.25 2.78 1.52

Changes 40.00 % 0 % -35.25% -50.00 %2012 0.14 3.25 1.80 0.76

Changes -21.43 % 0 % 30.56% 53.95 %2013 0.11 3.25 2.35 1.17

17

Table 3. Economic Growth in ExpansionYear Real GDP

($ Billion)Private

ConsumptiDomestic

Investment Total

Government Unemployme

nt (%)1971 -- 19721970 4722.00 2740.20 170.10 296.09 4.98

Changes 3.30% 3.81% 15.70% 10.24% 19.40%1971 4877.60 2844.60 196.80 321.84 5.95

Changes 5.20% 6.15% 15.96% 9.43% -5.88%1972 5134.30 3019.50 228.20 354.79 5.60

1983 -- 19901982 6491.30 3876.70 581.00 1073.12 9.71

Changes 4.60% 5.72% 9.72% 8.83% -1.12%1983 6792.00 4098.30 637.50 1179.43 9.60

Changes 7.30% 5.30% 28.64% 5.47% -21.79%1984 7285.00 4315.60 820.10 1283.58 7.51

Changes 4.20% 5.21% 1.17% 10.52% -4.22%1985 7593.80 4540.40 829.70 1353.81 7.19

Changes 3.50% 4.05% 2.35% 6.44% -2.67%1986 7860.50 4724.50 849.20 1496.29 7.00

Changes 3.50% 3.09% 5.06% 4.35% -11.79%1987 8132.60 4870.30 892.20 1592.72 6.18

Changes 4.20% 4.03% 5.02% 6.58% -11.07%1988 8474.50 5066.60 937.00 1662.02 5.49

Changes 3.70% 2.83% 6.69% 7.52% -4.25%1989 8786.40 5209.90 999.70 1771.33 5.26

Changes 1.90% 2.04% -0.62% 9.68% 6.81%1990 8955.00 5316.20 993.50 1904.54 5.62

1992 -- 20041991 8948.40 5324.20 944.40 2088.85 6.85

Changes 3.60% 3.41% 7.26% 5.51% 9.37%1992 9266.60 5505.70 1013.00 2230.30 7.49

Changes 2.70% 3.55% 9.26% 3.21% -7.79%1993 9521.00 5701.20 1106.80 2353.13 6.91

Changes 4.00% 3.82% 13.53% 3.53% -11.70%1994 9905.40 5918.90 1256.50 2428.59 6.10

Changes 2.70% 2.70% 4.85% 5.04% -8.33%1995 10174.80 6079.00 1317.50 2514.26 5.59

Changes 3.80% 3.49% 8.70% 3.33% -3.28%1996 10561.00 6291.20 1432.10 2640.93 5.41

Changes 4.50% 3.69% 11.42% 3.57% -8.63%1997 11034.90 6523.40 1595.60 2728.78 4.94

Changes 4.50% 5.24% 8.76% 3.83% -8.94%1998 11525.90 6865.50 1735.30 2826.20 4.50

Changes 4.70% 5.42% 8.58% 4.26% -6.30%1999 12065.90 7237.70 1884.20 2934.49 4.22

Changes 4.10% 5.07% 7.94% 6.22% -5.93%

18

2000 12559.70 7604.60 2033.80 3059.39 3.97Changes 1.00% 2.71% -5.17% 5.86% 19.54%

2001 12682.20 7810.40 1928.60 3249.60 4.74Changes 1.80% 2.66% -0.19% 7.83% 21.97%

2002 12908.80 8018.30 1925.00 3439.99 5.78Changes 2.80% 2.82% 5.35% 6.20% 3.60%

2003 13271.10 8244.50 2028.00 3709.39 5.99Changes 3.80% 3.29% 12.26% 5.38% -7.51%

2004 13773.50 8515.80 2276.70 3939.44 5.542010 -- 2012

2009 14418.70 9032.60 1878.10 5360.08 9.28Changes 2.50% 1.81% 11.86% -0.13% 3.68%

2010 14783.80 9196.20 2100.80 5974.77 9.63Changes 1.60% 2.53% 6.62% 3.27% -7.19%

2011 15020.60 9428.80 2239.90 5967.28 8.93Changes 2.30% 1.85% 10.68% -0.20% -9.61%

2012 15369.20 9603.30 2479.20 6162.33 8.08Changes 2.20% N/A 6.81% -1.11% -8.98%

2013 15710.30 N/A 2648.00 6150.02 7.35

Table 4. Interest Rate Changes in RecessionYear Federal Funds Rate Prime INT Rate 10yr T-Bond Yield 5yr T-Bond Yield

1969 -- 19701968 5.66 6.31 5.64 5.70

Changes

45.05% 26.15% 18.26% 21.58%1969 8.21 7.96 6.67 6.93

Changes

-12.67 -0.63 10.19 6.491970 7.17% 7.91% 7.35% 7.38%

1979 -- 19821978 7.94 9.06 8.41 8.32

Changes

41.06% 39.85% 12.13% 14.30%1979 11.2 12.67 9.43 9.51

Changes

19.20% 20.44% 21.21% 20.40%1980 13.35 15.26 11.43 11.45

Changes

22.77% 23.66% 21.78% 24.45%1981 16.39 18.87 13.92 14.25

Changes

-25.32% -21.30% -6.54% -8.70%1982 12.24 14.85 13.01 13.01

2008 -- 20092007 5.02 8.05 4.63 4.43

Changes

-61.75% -36.77% -20.95% -36.79%2008 1.92 5.09 3.66 2.8

Changes

-91.67% -36.15% -10.93% -21.43%2009 0.16 3.25 3.26 2.2

19

Table 5. Economic Growth in Recession

Year

Real GDP

($ Billion)

Private Consumptio

n($ Billion

Domestic Investment (Nominal $

Billion)

Total Government Spending (Nominal $

Billion)

Unemployment (%)

1969 -- 19701968 4569 2580.7 156.9 248.07 3.56

Changes

3.10% 3.75% 10.64% 6.82% -1.87%1969 4712.5 2677.4 173.6 277.19 3.49

Changes

0.20% 2.35% -2.02% 8.70% 42.72%1970 4722 2740.2 170.1 296.09 4.98

1979 -- 19821978 6267.2 3691.8 478.4 668.17 6.07

Changes

3.20% 2.38% 12.81% 9.82% -3.57%1979 6466.2 3779.5 539.7 734.47 5.85

Changes

-0.20% -0.35% -1.78% 16.57% 22.65%1980 6450.4 3766.2 530.1 806.57 7.18

Changes

2.60% 1.52% 19.07% 14.13% 6.16%1981 6617.7 3823.3 631.2 940.24 7.62

Changes

-1.90% 1.40% -7.95% 9.91% 27.46%1982 6491.3 3876.7 581 1073.12 9.71

2008 -- 20092007 14873.7 9262.9 2643.7 4720.89 4.62

Changes

-0.30% -0.55% -8.28% 8.33% 25.63%2008 14830.4 9211.7 2424.8 4948.04 5.8

Changes

-2.80% -1.94% -22.55% 11.47% 60.06%2009 14418.7 9032.6 1878.1 5360.08 9.28

20

Table 6. Exports and Imports of Goods and Services by Type of Product ($billions)Consumer goods, except food and automotive 447.6 479.8 485.7 429.9 485.1 515.9 518.8 533.9

Other 87.2 88.8 86.5 80 93.1 97.1 102.6 106.1Imports of services 1 347.6 379.4 415.6 392.9 415.2 441.6 456.4 468.1Transport 78 79.3 84 64.1 74.6 81.4 85 90.8Travel (for all purposes including education) 84.2 89.2 92.5 81.4 86.6 89.7 100.3 104.7

Charges for the use of intellectual property n.e.c. 25 26.5 29.6 31.3 32.6 36.1 39.5 39

Other business services 3 126.6 149.3 174 178.5 183.6 197.3 197.7 202.3Government goods and services n.e.c. 27.4 28.3 28.9 31.5 32 31.3 27.9 25.3

Other 6.4 6.8 6.6 6.1 5.9 5.9 6.1 6Addenda:Exports of durable goods 715 782.9 829.2 671.6 801.4 894 940.9 957.3Exports of nondurable goods 334.6 383.5 469.6 393.5 478.2 572.9 586.2 605.5Exports of agricultural goods 4 72.9 92.1 118 101 119 140 145 148.3

Exports of nonagricultural goods 976.7 1074.

31180.

8 964.1 1160.6

1326.8 1382.2 1414.6

Imports of durable goods 1131.2 1176.2 1163 893.8 1106.

91238.

7 1328.7 1360.5

Imports of nondurable goods 768.5 827.5 986.4 696.5 842.9 1006 977.4 941.7Imports of nonpetroleum goods 1583 1657.

11673.

31322.

61596.

21782.

6 1871.7 1914.6

Table 7. Real Exports and Imports of Goods and Services by Type of Product,

21

Chained Dollars (billions)2006 2007 2008 2009 2010 2011 2012 2013

Exports of goods and services 1506.8 1646.4 1740.8 1587.7 1776.6 1898.3 1960.1 2019.8

Exports of goods 1 1062 1141.5 1211.5 1065.1 1218.3 1297.6 1344.9 1382.9Foods, feeds, and beverages 84.8 92.2 98.4 93.9 103.6 103.3 102.3 104.5

Industrial supplies and materials 270 284.5 315.6 293.5 339.4 361.5 367.5 382.5

Capital goods, except automotive 399.3 431.8 457.7 391.5 445.1 487.2 515.8 519.3

Automotive vehicles, engines, and parts 110.4 123.4 122.3 81.7 111.5 130.1 140.5 145.8

Consumer goods, except food and automotive

134.8 149.3 161.5 149.3 163.1 170.5 174.1 183.1

Other 3 66.4 65.1 59.2 55.2 55.6 46.8 49.8 51.7Exports of services 1 443.5 504.1 528.3 522.6 558 600.6 614.7 636.6Transport 60.3 65.8 68.7 62.2 65.9 67.7 68.8 72.3Travel (for all purposes including education)

111.5 121.5 130.3 119.9 132.9 139.2 144.6 153.9

Charges for the use of intellectual property n.e.c.

88.6 100.7 101.9 98.4 105.9 118.5 118.5 120.5

Other business services 4 153.8 185.9 199.5 210.9 224.3 241.3 249.1 256.3

Government goods and services n.e.c. 20.1 21.3 18.2 19.8 18.4 22.1 22.2 22.3

Other 9.2 9 9.5 11.4 10.6 12.3 11.9 11.3Residual -2.9 -4.6 -2.2 -0.1 -0.1 -2.9 -4.6 -2.4Imports of goods and services 2301 2359 2298.6 1983.2 2235.4 2357.7 2412.6 2440.3

Imports of goods 1 1925.4 1960.9 1887.9 1590.3 1826.7 1932.1 1973.1 1991.5Foods, feeds, and beverages 87.8 88.9 87.9 82.9 84.8 86.4 89.6 93.1

Industrial supplies and materials, except petroleum and products

292.3 280.9 260.1 196.6 225.3 239.6 245.5 249.5

Petroleum and products 309 301.7 291.3 267.7 269 263.9 242.5 225.1

Capital goods, except automotive 414.9 442.9 450.1 374.1 453.8 516.2 553.6 565.1

Automotive vehicles, engines, and parts 267.1 267.1 235.5 159.2 224.2 245.8 281.4 292.7

22

Consumer goods, except food and automotive

463.2 489.9 484 429.9 485.4 507.4 502.9 518.6

Other 95 95.1 84.5 80 90.5 91 95.3 98.4Imports of services 1 370.5 393.5 408.2 392.9 407.8 424.2 438.7 448.4Transport 79.5 80.8 77.6 64.1 68.3 70.5 72.5 76.8Travel (for all purposes including education)

93.9 91.9 89.5 81.4 84.8 85.5 95.4 98

Charges for the use of intellectual property n.e.c.

26.6 27.3 29.6 31.3 32.1 34.7 37.3 36.4

Other business services 4 131.5 156.3 176.9 178.5 184.2 197.9 199.5 206.7

Government goods and services n.e.c. 31.6 29.2 27.8 31.5 32.5 30.2 28 24.5

Other 6.6 6.9 6.3 6.1 5.8 5.6 5.6 5.5Residual 1 -0.9 -3.1 0 -5.5 -16.7 -36.1 -49.3

23