BBS Financial Engineering

STRATHMORE INSTITUTE OF
MATHEMATICAL SCIENCES

109716 - Ndunda Nthuli Jonathan

110644 - Kuria Cassandra Wangui
110843 - Oluoch Geoffrey Were
098750 - Kiprop Jepkemoi Joanne
111089 - Rajgor Jay Vinesh

TIME SERIES ANALYSIS

Experiential
Analysis of USA
Interest Rates
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Table of Content
1. Abstract ................................................................................................................................... 3

2. Conceptual Framework ............................................................................................................ 4

2.1 Introduction
2.2 Variable verification
2.2.1. Dependent variable
2.2.2. Independent variable

3. Literature Review .................................................................................................................... 7

3.1 Univariate Time Series Analysis
3.2 Multivariate Time Series Analysis

4. Methodology ............................................................................................................................ 9
4.1 Explanatory Analysis
4.2 Explanatory Tests for Stationarity

4.3 Univariate Time Series Analysis

4.3.1. AC and PAC Graph

4.3.2. Model Complexity
4.4 Multivariate Time Series Analysis
4.4.1. Test for Cointegration
4.4.2. Error Correction Model
4.5 Impulse Response
4.6 Variance Decomposition
5. Conclusion ............................................................................................................................... 43

6. References ............................................................................................................................... 44

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 1. Abstract
Interest rates are the reward paid by a borrower (debtor) to a lender (creditor) for the use of
money for a period, often referred to as the price of money. Are expressed in percentage terms to
make them comparable. Interest rates have proven to be one of the most volatile variables in the
economic sector. Even with its volatility, interest rates are important in pricing of most financial
instruments by investors and other areas as well. This then means that interest rates have a very
huge and significant effect on the economy of a country and its growth. There are different types
of interest rates, nominal interest rate, effective rate, and real interest rates. We will majorly
focus on the nominal interest as it is used the most.
Asset pricing models predict a strong connection between the real risk-free interest rate and the
macroeconomy and that is why in this report we use some of the factors that affect interest rates
to analyze and determine the its effect to the economy and how it affects economic growth.
Interest rates therefore will act as our dependent variable and factors like gross domestic product
growth (GDP growth), unemployment and inflation are used to come up with a model that will
help us analyze and interpret how significantly interest rates affect the economy.

Keywords: interest rates, economic growth, financial instruments, economy, inflation rate,
unemployment rate, gross domestic product (GDP), GDP growth.

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 2. Conceptual Framework.
2.1 Introduction.
Objective: The main purpose of this report is to observe, assess and forecast the impact that
Economic growth of the United States of America has on its nominal interest rates.
The key to progress and/or any growth of sorts for any nation is investment. An encouragement
towards investment is the first step towards growth. This report highlights the impact of one of
the major factors that influence volume of investments; Interest rates. Selectively focusing on the
globe’s major player; the United States of America and how various factors play a key role in the
movement of the country’s nominal interest rates. These rates are those which lay the ground
works for investments and related opportunities, which are the founding steps of Economic
Growth.
Our interest peaked on the United States because it offers the largest consumer market on earth
with a GDP of $20 trillion and 325 million people. Household spending is the highest in the
world, accounting for nearly a third of global household consumption. At the same time, free
trade agreements with 20 other countries provide enhanced access to hundreds of millions of
additional consumers – and the United States continues to work with companies to increase
opportunities for U.S. exporters. Due to the United States hosting the largest markets and having
a large pool of resources, the country has emerged with one of the most developed, liquid,
flexible, and efficient financial markets in the world. A wide range of funding sources – from
banks and investment firms to venture capitalists and angel investors – enable innovation and
expansion, giving companies in the United States an important advantage.
It is for reasons as those mentioned above that our interest hovered around the United States, and
it led us to take up the initiative to investigate the country’s economic growth and its impact on
interest rate through examination of the interest rates and related variables of growth over an
elongated time frame.
This report brings together concepts derived from time series analysis of data to model the
dependency of the US interest rates on the country’s inflation rates, GDP growth and
unemployment rates. Taking a span of 59 years of data collection our research tries to check on
the validity of our hypothesis – impact that GDP rate, inflation rates and unemployment rates
have on interest rates. Illustrating the summary statistics and the explanatory analysis generates a
good start with a decent visualization on the type of data being worked with. Our study then
checks for the non-stationarity of our variables which indicates whether the variables are
justifiable to be carried for further modelling on the hypothesis. The next step elaborates on the
univariate analysis (using the Box Jenkins method) of the stated variables. After which the
crucial test of co-integration is carried out. The final phase is to carry through the multivariate
analysis (using the VAR or VECM).

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 2.2 Variable Verification.
This section illuminates on the plausibility and connectivity of our independent variables in
relation to our dependent variable.

2.2.1 Dependent Variable.

Nominal Interest Rate.
The nominal interest rate is the interest rate that has not yet had inflation accounted for in the
overall number. This interest rate will be quoted on things like loans, bonds, and the like. It is the
rate “as advertised,” which will not necessarily reflect the reality of how the interest rate will
actually manifest as influenced by inflation, compounding interest, taxation, fees, and other such
factors.
The nominal interest rate is otherwise known as the annualized percentage rate, which is the
interest compounded once per year. The interest rate in question by our study can be
approximated by the formula.
Interest Rate = ß0 + ß1(CPI) + ß2(GDP) + ß3(unemployment rate) + α
Where α = error term

2.2.2 Independent Variables

Inflation Rate (CPI)
Engraved into any/all economist’s veins inflation is defined as a sustained increase in the general
price level of goods and services in an economy over a period of time. In this report the inflation
rate is being represented by the CPI (Consumer Price Index) wish is a measure that examines the
weighted average of prices of a basket of consumer goods and services, such as transportation,
food, and medical care etc.
The relationship between inflation rate and interest rate can be demonstrated under a system of
fractional reserve banking, interest rates and inflation tend to be inversely correlated. This
relationship forms one of the central tenets of contemporary monetary policy: Central banks
manipulate short-term interest rates to affect the rate of inflation in the economy.
In general, as interest rates are reduced, more people are able to borrow more money. The result
is that consumers have more money to spend, causing the economy to grow and inflation to
increase. The opposite holds true for rising interest rates. As interest rates are increased,
consumers tend to save as returns from savings are higher. With less disposable income being
spent as a result of the increase in the interest rate, the economy slows, and inflation decreases.

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Gross Domestic Product (GDP growth)
This is one of the key founding basics of economics and can be defined as - Gross domestic
product (GDP) is a monetary measure of the market value of all the final goods and services
produced in a specific time period.
Generally, the economic growth rate can be impacted adversely by interest rates only in the short
term, for instance, in the short term, high interest rates may slow down growth because slower
investments and high interest rates raise the inflation expectation. This then leads to a decline in
demand, slowing down the growth percentage.
However, in the long term there are no clear relations between the lending rate and the growth
rate of the economy. In the long term, growth is significantly impacted by numerous variables
like the productivity of the industry, the technology used, the innovation by the industry, the
taxation system, the efficiency of infrastructure and the framework of policies and procedures.

Unemployment Rate
Another key fundamental of economics, defined as; The unemployment rate is the proportion of
the labor force that is not currently employed but could be. It is a lagging indicator, meaning that
it generally rises or falls in the wake of changing economic conditions, rather than anticipating
them.
The exact relationship between unemployment and interest rates is less than satisfying when
viewed using different sets of data in real time. Sometimes it appears to be an inverse
relationship, and sometimes they appear to move together. Thus, one can find him/herself able to
support either side of the argument, depending on which data one looks at.

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 3. Literature Review.
This project provides a brief overview of how the model we have created would assist in
forecasting f. Research has been conducted that looks to explain how each of the explanatory
variables(CPI, Inflation, Unemployment) affects the dependent variable(Interest rates).
“Handbook of Univariate and Multivariate Data Analysis with IBM and SPSS” was the text
used as the research material. This book was authored by Robert Ho and stated that for a model
to be forecasted, one would first need to establish the relationship between the variables by
carrying out a Univariate or Multivariate Time Series analysis.

3.1 Univariate Time Series Analysis.

Using the book, Robert Ho was able to state that this type of analysis involved using current
values of the explanatory variable that have been determined in the past to explain the dependent
variable. It also involves the use of structural models, models established to explain the
dependent variable by use of economic theory given the independent variables. Univariate time
series models are used when one is unsure of the accuracy of the structural model in question.
Through research based on this topic, we have discovered that there are various types of models
involved:
• Autoregressive models of order 1 and 2.
• Moving Average models of order 1 and 2.
Autoregressive models look at the lags of dependent variables whereas the Moving Average
models look at the lags of the regressed error terms. Moreover, it is important to note that
moving average models are always stationary. This is because the regressed error terms are white
noise processes which then help to explain “shocks” overtime.
For a model to be forecasted using the Univariate Time Series Analysis, it would require the use
of the Box Jenkins Methodology. This involves systematically identifying, fitting, checking and
using integrated autoregressive moving average models to forecast. Once a model has surpassed
this methodology, the model complexity is brought into question. This involves looking at the
information criterion (Akaike and Bayesian) such that the best model to use for forecasting is the
model that has the lowest information criterion.

3.2 Multivariate Time Series Analysis.

Looks at the Vector Autoregressive Model (VAR)
Most common case of this analysis is the use of the Bivariate VAR.
This involves looking at two variables, each of whose current values depend on the different
combinations of the previous lags of both variables and error terms. In this type of analysis, all
explanatory variables are endogenous. Its distinction from the Univariate Time Series analysis is
that it does not employ use of economic theory. This is a suitable model used in describing the
data generating process because of its various advantages which include:

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 • One does not need to specify which variables are endogenous or exogenous since it is
known that all the variables are endogenous.
• VAR allows the value of a variable to depend on more than just its own lags or
combinations of white noise terms.
For a model to be forecasted using Multivariate time series analysis, it would require the use of
the Wald Test (Grayan Casuality Test). This test basically involves using past lags to predict the
future.
In deeper terms, this test looks at the forecasting ability of two independent events say Y and X.
If Y followed X then we can say that Y helps forecast X. The best model to use to forecast is the
model that has the lowest lags once the test has been conducted.

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 4. Methodology
4.1 Explanatory Analysis
This section provides the statistical analysis, accompanied with visual representation, of our
variables put into question by the research topic. This analysis covers measurements such as
mean, variance, standard deviation, skewness, kurtosis, and interquartile figures of the said
variables:
• Dependent variable

The observed mean of the US interest rates is quite a low figure compared to countries such as
Brazil and Madagascar which have been viewed to have some of the highest interest rates over
the same observed period. A low interest rate would imply a lower level of risk for investors.
With the standard deviation and variance being a relatively low figure as well, it would imply
that there is relatively good flow of information and little to no arbitrage opportunity (yet again
enforcing low levels of risk) when it comes to investment opportunities as the interest will not
deviate that far off from the mean over the period of time within the period of data that has been
collected.
The Skewness value indicates that the interest rate distribution is not symmetrical, and neither is
it normally distributed. This accompanied by the large value of Kurtosis points towards a high
peak, i.e. most of the observations are concentrated around a certain value(s). this is represented
graphically below:

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 The positive
Skewness shows
that distribution is
weighted heavily
on the RHS and
the high Kurtosis
shows that the
highest densities
are between the
range approx. 4-6
while the rest are
relatively low

• Independent variables

The CPI is the measure that we are using to give us an impression of inflation rates in the USA.
Ergo, with retrospect to inflation, the mean of the CPI is a relatively low figure (in comparison
to other countries observed in the same time frame). This indicates that the general inflation rates
have been low over the 59 year time frame.
The standard deviation and variance adds to this conclusion; this low values of said statistics
indicate that the inflation has been growing at a small, if not stagnant rate. A less volatile
inflation rate would mean that calculating present/future values are easily and more accurately
done, hence a less risk less environment.

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Skewness value hints that the distribution is not symmetric nor normal, with the Kurtosis value
being large enough to suggest the observations are concentrated around a certain value(s). as
represented graphically below:
The positive
Skewness shows
that distribution
has more weight
on the RHS, and
the high Kurtosis
shows that the
highest densities
are between the
range approx. 2.5
- 5.2 while the
rest are relatively
low

The GDP growth rate (gr) shows economic growth of US. The mean of GDP gr is a positive
value indicating and overall growth of the economy of US. Though the value may appear to be
small, it can be described as a steady growth over the 59-year span (which is no easy fit to
accomplish).
The observed standard deviation and variance appear to have the commonality as CPI, in that
both values are relatively low, implying low level of growth, however they are steady in their
movement. This high viscosity of standard deviation and variance is an indication of a well
maintained economy.

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Discussing the Skewness; note the negative figure, implying a non-symmetric and not normal
distribution, however its magnitude is so close to zero it seems to be reaching towards the normal
distribution. The Kurtosis on the other hand shows the observations are concentrated around a
certain value(s). as demonstrated below:
The negative
Skewness shows
that distribution
weighted on the
LHS, but because
of the low value,
there are densities
on the RHS, and
the high Kurtosis
shows that the
highest densities
are between
approx. 1.5 - 3.2

The mean of the unemployment rate does seem to be above the recommended Federal Bank
percentage of 3.5% - 4.5%. This is seen to be a constant since 1961, however it has been
dropping in since the last decade.
Looking at the standard deviation and variance, it can be said that unemployment rate has had
one of the lowest (especially in comparison to the other variables being applied to this study)
values. These small deviations is an indication of well controlled variable even when considering
the passage of time and the increase in general population.
Observing the Skewness; it is clear that the distribution is not symmetrical nor normal. However,
it does represent both sides from the mean due its closeness to zero. The Kurtosis is again a high

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value which means most observations are concentrated around a certain value(s). as shown
below:

The positive
Skewness shows
that distribution
weighted on RHS,
and the high
Kurtosis shows
that the highest
densities are
between approx.
4.8 – 6.4 while
the rest are
relatively low

• To sum up;

The box plot above represents all the analysis of all the variables in a pleasantly summarizes
version; showing the distributions of interest rates and unemployment rates being non-normal,
and how close to normal the distributions of the GDP growth and CPI are. With the representation
of the outliers and inter quartile range; Interest rates = 10 pts, CPI = 9 pts, GDP growth = 9 pts and
unemployment rate = 7 pts, giving us a more vivid illustration of the data and its nature.

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The line graph above shows the nature of the data (variables in observation) to the time period
and how they behave to certain events in relation to one and other. For instance, the infamous
1980 economic crisis; all the variables experience a rise except the GDP growth, which elaborates
on the correlations that these variables have with each other. This graph also demonstrates how
certain phenomena affects these variables and how they recover over time. For example, the CPI
rate had a steeper fall than the interest rates during the mentioned economic crisis, while
unemployment was the least affect (i.e. in retrospect of the other variables).

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 4.2 Explanatory Tests for Non-Stationarity
To conduct empirical analysis of our study and its related variables, the variables need to get
tested for non-stationarity. To understand this concept, we need to look at what is stationarity of
time series data. A stationary time series is one whose statistical properties (such as mean,
variance, autocorrelation, etc.) are all constant over time. Therefore, non-stationarity means that
the time series data exhibits statistical properties that are not constant over time.
In this study, we are after stationary set of time series data, in other words, the variables are
supposed to exhibit stationary properties of time series data. This is important in order for us to
carry out further modelling of our hypothesis through the Univariate analysis (via Box-Jenkins
method) and Multivariate analysis (the VAR and VECM). For this reason, this section of
methodology puts the variables through the test of non-stationarity.
In order to observe whether the time series data is exhibiting stationary or non-stationarity
behavior, we carry out the Dickey Fuller test; where each variable is modelled under the
function;
Y t = ρ Y t-1 + μ t
Where:
1. Y t = variable at time t
2. ρ = coefficient of the lag Y t-1
3. Y t-1 = lagged variable by 1
4. μ t = white noise process
key aspect to note, if;
ρ = 1 - (non-stationary), ρ < 1 - (stationary), ρ = 0 - (white noise process)

To check for non-stationarity of variable a t-test is carried out on the variable with hypothesis
ρ = 1. However, a direct t-test would result in many biases, due to model displaying unit root
properties, therefore we manipulate the model to generate;
Δ Y t = (ρ-1) Y t-1 + μ t
Where (ρ-1) can be represented by δ to generate the null hypothesis:
H0: δ = 0, since ρ = 1 (non-stationary)
H1: δ < 0 (stationary)

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In STATA, the tau test statistic (i.e. the min MAIC) is what will be generated from using the DF-
GLS test for unit root, which is then compared to the confidence interval (99%) value or critical
value (1%) and this shows the stationarity of the variable.
The Dickey Fuller GLS test results:
• Dependent variable
Interest Rates

For the interest rates, we look at the tau statistic of the min MAIC at lag 4 which is in the bounds
of the 1% critical value, i.e. the magnitude is 1.286 < 3.736. since it falls under the confidence
interval, we conclude that we fail to reject the null hypothesis (H0). Ergo, Interest rates do
demonstrate non-stationary behavior.

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 • Independent variables
CPI

The CPI generates the tau statistic of the min MAIC at lag 4 which is in the bounds of the 1%
critical value, i.e. the magnitude is 1.204 < 3.736. since it falls under the confidence interval, we
conclude that we fail to reject the null hypothesis (H0). Therefore, the variable CPI is non-
stationary.
GDP gr

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The GDP gr generates the tau statistic of the min MAIC at lag 1 which is out of the bounds of the
1% critical value, i.e. the magnitude of the tau statistic is 5.372 > 3.736. since it falls beyond the
confidence interval, we conclude that we reject the null hypothesis (H0). Therefore, the variable
GPD gr is stationary.
Unemployment Rate

Observing the unemployment rate, we look at the tau statistic of the min MAIC at lag 2 which is
in the bounds of the 1% critical value, i.e. the magnitude is 2.704 < 3.736. since it falls under the
confidence interval, we conclude that we fail to reject the null hypothesis (H0). Thus,
Unemployment rates do demonstrate non-stationary behavior.
• Observations made.
It has been made clear that out of the four variables only the GDP gr is portraying stationarity in
its data while the other three, namely, interest rates, CPI and unemployment rates display non-
stationary behavior. To carry out further analysis we need to transform the remaining variables
into stationary time series data.
• Changing Non-Stationary data into Stationary data
In order to change a non-stationary data set into a stationary data set, we simply subtract the
variable by its lagged self. A clearer formulation would appear as:
Y stationary = Y t – Y t-1
In STATA, this is generated by the command:
generate NVar = Var – l. Var

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Variables changed to Stationary time series data and tested using the DF-GLS:
• Dependent variables
Interest rate

Now it can be seen that the interest rates (dInterestRates) have stationary properties, that is, now
the tau statistic of min MAIC at lag 1 is out of bounds from the 1% critical value, in other words
the magnitude of tau statistic of dInterestRates 5.880 > 3.740 1% critical value. Hence, interest
rates are now stationary time series data set.

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 • Independent variables
CPI

The new observations show that the CPI (dCPI) have stationary properties, that is, now the tau
statistic of min MAIC at lag 1 is out of bounds from the 1% critical value, in other words the
magnitude of tau statistic of dCPI 6.917 > 3.740 1% critical value. Hence, CPI now show
properties of a stationary time series data set.

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Unemployment rate

The new test results show that the Unemployment rate (dUnemploymentRate) has stationary
properties, since the tau statistic of min MAIC at lag 1 is out of bounds from the 1% critical
value, this means that the magnitude of tau statistic of dUnemploymentRate 5.174 > 3.740 1%
critical value. Ergo, dUnemploymentRate now show properties of a stationary time series data
set.

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 4.3 Univariate Time Series Analysis.
AC GRAPGH
ac dInterestRates, lags(12)

This is an AC curve of up to 12 lags.

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PAC GRAPGH
pac dInterestRates, lags (12)

Here we have a PAC graph also of up to 12 lags.

From the AC graph, we observe a significant spike at lag one hence we use Moving Average
(MA) Model at lag 1 [MA (1)].
Again, from the PAC graph we observe significant spikes now at lag 1 and lag 2.
We run Autoregressive Model [AR] on these two lags: AR (1) and AR (2).

From our cheat sheet, we conclude that the best model to use is the ARIMA model. We run the
ARIMA code on dInterestRates, predict its residuals and test the m to see if they are white noise.

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From the results, our p value (0.1388) is greater than our level of confidence (0.05) hence we fail
to reject our null hypothesis which implies that our residuals are stationary hence white noise.

From the results, our p value (0.1080) is greater than our level of confidence (0.05) hence we fail
to reject our null hypothesis which implies that our residuals are stationary hence white noise.

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From the results, our p value (0.2532) is greater than our level of confidence (0.05) hence we fail
to reject our null hypothesis which implies that our residuals are stationary hence white noise.

With sufficient tests using the Box-Jenkins Methodology to identify, estimate and do diagnostic
checking, we were able to conclude that our residuals are a white noise since our p values are all
greater than the level of confidence of 0.05 hence, we fail to reject the null hypotheses, which
implies that the residuals are all stationary hence white noise.

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MODEL COMPLEXITY.
Here, we try to choose a model that will be the simplest of them all but has the greatest number
of variables required. We try to balance to know the least number variables are significant and
are needed for our model to work well but also avoid leaving necessary ones.

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We now compare the two models’ BIC. Model 1 has a BIC of 225.5047 while model 2 has a BIC
of 227.1419. Model 2 has a greater BIC than model 1 and hence we choose model 1 as our
simplest model.
For model evaluation, our preferred model was the MA (1) since it’s a smaller model as it has
the least BIC which penalizes having more parameters hence our estimated coefficients are as
small as need be.

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 4.4 Multivariate Time Series Analysis.
Under Multivariate Analysis, we are trying to establish whether there exists cointegrating
relationships between different variables.
We examine the values in their original form

a. TESTS OF COINTEGRATION

1. Engle Granger Test- Used when trying to establish whether there exists a cointegration
relationship between two variables that are non-stationary
2. Johansen Cointegration Test
Johansen test is used in this case because we are trying to establish whether there is more than
one cointegrating relationships where more than two variables are in use.

From the table, we derive that there are at most 3 cointegrating relationships.
We conclude that there is presence of cointegration because at maximum rank 3, the test
statistic is less than the 5% critical value, therefore we fail to reject the null hypothesis.
With the knowledge that there exists at most three cointegrating relationships, we wish to
identify the unknown variables that are cointegrated with each other. This is done by running
an error correction model to estimate the final model.

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 b. ERROR CORRECTION MODEL.

These are used to model the long run relationships between variables by considering the first
differences of the structural model.

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32
33
34
35
36
From the table above, we are able to establish the short run relationships that exist between the
variables.

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From the table above, we derive that there exists a long run relationship the different
variables (Interest rates, CPI, Unemployment rate and GDP).
For both _ce1 and _ce2, there exists a relationship which is significant since the p value is less
than the 5% level of significance. In the first cointegrating equation we see a long-run
relationship between Interest rates and Unemployment rate and in the second cointegrating
equation we see a long-run relationship between CPI and Unemployment rate
For _ce3, there exists a relationship but it is insignificant since the p value is greater than the
5% level of significance. The insignificant relationship that exists is between GDP growth and
Unemployment rate.

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4.5 IMPULSE RESPONSE
The Granger Causality test above suggests which variables in the model have statistically
significant impacts on the future values of each variable. Through VAR’s impulse responses
and decompositions, the positive or negative effect on other variables by a given variable in a
system is revealed. In addition to this, it also tells us how long the effect of the variable takes
to work through the system. Heres we discover the reaction of a response variable to a onetime
shock in an impulse variable. We have 16 possible responses to shocks from our 4
variables.
Below are the graphs of the respective variables to shocks

The first row--Impulse variable: CPI

When CPI is shocked, the response of CPI is volatile. The initial reaction was a decrease,
followed by an increase and a decrease before the shock eventually dies down since the shock

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in itself will affect itself since the lags of the CPI will affect CPI. The response of the GDP is
also
volatile. The response of interest rates and unemployment rates is smooth. The initial
response of unemployment rates is a decrease followed by a slight increase before the shock
dies down.
The second row--Impulse variable: GDP growth
When GDP growth is shocked, the response of the other variables is volatile-seemingly
following a trend (steep upward and downward fluctuations). The shock does not die down
quickly and the response of GDP starts at 2 when shocked since the shock in itself will affect
itself since the lags of the GDP will affect GDP
The third row—Impulse variable: Interest rates
When interest rates is shocked, the response of CPI and interest rates is a slight increase
followed by a sharp decline. There are fluctuations but the shock does not die down rapidly.
The response of unemployment rates involves a slight increase before the shock gradually
decreases.
The fourth row—Impulse variable: Unemployment rates
When unemployment rates is shocked, the response of the other variables is less volatile
compared to the other shocks. The shock gradually dies down; faster than the other shocks.

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 4.6 VARIANCE DECOMPOSITION
Variance decompositions indicate the proportions of the movement of the dependent variable
that are due to its own shocks and shocks of other variables.
Below is the Variance decomposition table:

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From (1) to (4), the variable interest rates is shocked and we observe the movements of the
other variables. A higher proportion of the movement caused by the shocks is on Interest
rates. Therefore, we observe that the proportion of interest rate movements is caused by its
own shocks. Over time, the proportion of movements of the other variables due to shocks
increases.
The same applies to the other variables, CPI, GDP growth and Unemployment rates. The
highest proportion of each of the variables movements is due to its own shocks. Over time,
the effect of its own shocks decreases and the proportion due to the other variables’ shocks
increases. The total effect/ proportion of the movements should equal to 1.

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 5. Conclusion.
In our report, we study the Empirical Analysis of the US economic growth and its impact on
interest rates. With interest rates as our dependent variable, this is because interest rates
determine money’s value, we took a couple of factors that may affect it as our independent
variables, GDP growth, CPI, and unemployment rate, which are major players of Economic
growth.
US is one of the most stable countries as most of the variables all have very small deviations in
comparison to other countries and very small means as well. Inflation rate are less volatile
making calculations of present and future values very easy and accurate. The GDP growth rate
has been relatively low but very stable and due to low CPI, we see that their growth is not
majorly because of inflation but increase in production in the country. Unemployment rate there
has been constant since 1961 and started dropping in the last decade a sign of development.
Looking at interest rates, they have relatively been low implying a relatively good flow of
information and little to no arbitrage opportunity (yet again enforcing low levels of risk) when it
comes to investment opportunities as the interest will not deviate that far off from the mean over
the period of time within the period of data that has been collected.
We notice that unemployment rate has the least effect on interest rates as it is very low and has
been constant all through. It also has had the least effect on shocks in the economy. GDP growth
and CPI on the other hand, have big effects on interest rates and have also been hugely affected
by shocks across time.
Looking at how these variables have been affected with respect to some events in history we see
that for instance, the infamous 1980 economic crisis; all the variables experienced a rise except
the GDP growth, which elaborates on the correlations that these variables have with each other.
Interest rate changes affect a lot of things in the economy, with examples being stock prices,
wealth, and currency exchange rates. For instance, Ceteris paribus, lower interest rates tend to
raise equity prices as investors discount the future cash flows associated with equity investments
at a lower rate. Similarly, interest rates affect lending and borrowing. This then affects the supply
of money in the economy affecting other aspects of the economy.

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 6. References
Why invest in the United States. SelectUSA.gov
https://www.selectusa.gov/why-invest#:~:text=The%20United%20
States%20hosts%20the,United%20States%20an%20
important%20advantage.

Prateek Agarwal (5/11/2019).

Nominal Interest Rate. Intelligent Economist.
https://www.intelligenteconomist.com/nominal-interest-
rate/#:~:text=The%20nominal%20interest%20rate%20is%20
otherwise%20known%20as%20the%20annualized,interest%20rate
%20is%20inflation%2Fdeflation.

Krishna Koundinya (24/12/2014). Exploring the relation between

Interest Rates and the GDP Growth Rate in an Indian Context. Qrius
https://qrius.com/interest-rates-and-gdp-growth-rate/

McClellan. Economics Relationships.

Unemployment and Interest rates. McOscillator.
https://www.mcoscillator.com/learning_center/kb/economic_
relationships/Unemployment_and_Interest_rates/

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