Homework #4: Interest Rates, Shocks

Econ 352: Macroeconomics

Due at 11:59 p.m. EDT Tuesday May 28th.

Interest Rates and Inflation (8 pts)

1. Go to the “Federal Reserve Economic Data” (FRED) database at https://research.stlouisfed.org/fred2/

2. Find the three-month treasury bill: secondary market rate, and the consumer price index
for all urban consumers: all items.

3. Download both at a monthly frequency from 1947-present

4. Calculate the lagged yearly net inflation rate from the CPI data in percent terms. (For
period t, divide period t’s CPI by period t − 12’s CPI. This is gross inflation. Subtract
the gross inflation by 1 and multiply by 100 to get the net inflation rate in percent:
  
CP It
πt−12→t = 100 · CP It−12 − 1 )

Plot and compare the net inflation rate and the three-month treasury bill together from 1948-
present: what do you notice? In economics, you frequently see the “Fisher Equation”, which
is i ≈ r + π, or “the nominal interest rate is (to a first-order approximation) equal to the real
interest rate plus the inflation rate.” If the three-month treasury bill is i, and the inflation rate
you calculated is π, does your graph give you any information about whether r or π can explain
what’s going on with i? That is, when r or π moves, i moves by definition. We see a lot of
variation in i on your graph. Qualitatively, how much can be attributed to π vs. r?

1
Short Essay (7 pts)

If the Federal Reserve were to target the price level, so that Pt = P , how would money supply
change if productivity (At ) suddenly increased temporarily? Reason though what happens
to macroeconomic aggregates such as Yt , Lt , effective Kt (such as through changed capital
utilization), and how they cause the central bank to change money supply Mt to keep Pt constant.