Answer the following question using the FRED database. 

 

https://fred.stlouisfed.org 

 

1.1) 

 

(1.1a) Plot the three-month U.S. Treasury bill rate (FRED code: TB3MS) from 1960 to the present. What long-run pattern do you observe? What may have caused this pattern? 

 

(1.1b) Then, plot the inflation rate based on the percent change from a year ago of the U.S. consumer price index (FRED code: CPIAUCSL) from 1960 to the present. How does U.S. inflation history reflect your explanation in part (1a)? 

 

(1.2) 

 

The expected real interest rate is the rate which people use in making decisions about the future. It is the difference between the nominal interest rate and the expected inflation rate, not the actual inflation rate. 

 

(a) How does expected inflation over the coming year compare with actual inflation over the past year? 

 

(b) Plot the inflation rate since 1978 based on the percent change from a year ago of the U.S consumer price index (FRED code: CPIAUCSL). Add to this figure as a second line the expected inflation rate from the University of Michigan survey (FRED code: MICH). 

 

(c) Is expected inflation always in line with actual inflation? 

 

(d) Which is more stable?

check answer in the explanation box below

Step-by-step explanation

1.1

0.5 -1.5 0.5 1.5 -1 O b) a 10.00 14.00 18.00 16.00 0.00 12.00 2.00 4.00 6.00 8.00 1960-01-01 1961-04-01 1962-07-01 1965-01-01 1963-10-01 treasury bill. 1966-04-01 1965-01-01 1967-07-01 1966-04-01 decreasing trend. 1968-10-01 1967-07-01 1970-01-01 1968-10-01 1971-04-01 1970-01-01 1972-07-01 1971-04-01 1973-10-01 1972-07-01 1975-01-01 1973-10-01 1976-04-01 1975-01-01 1977-07-01 1976-04-01 1978-10-01 1977-07-01 1980-01-01 1978-10-01 1981-04-01 1980-01-01 1982-07-01 1981-04-01 1983-10-01 1982-07-01 1985-01-01 1983-10-01 decreasing trend in rates of the 3-month 1986-0 01 1985-01-01 expected inflation rate. Hence real interest equals the nominal interest rate minus the because of which real interest rates show a 1987-07-01 rates fall with increase in inflation. We see a 1986-04-01 We see continuous spikes in the inflation rate 1988-10-01 1987-07-01 The fischer effect states that real interest rate Inflation Rate 1990-01-01 1988-10-01 3-Month Treasury Bill 1991-04-01 1990-01-01 1992-07-01 1991-04-01 1993-10-01 1992-07-01 1995-01-01 1993-10-01 1996-04-01 1995-01-01 1997-07-01 1996-04-01 1998-10-01 K 1997-07-01 2000-01-01 1998-10-01 To-TO-000Z 2001-04-01 2001-04-01 2002-07-01 2002-07-01 2003-10 01 2003-10-01 2005-01-01 2005-01-01 2006 04 01 2006-04-01 2007-07-01 2007-07-01 2008-10-01 2010-01-01 2011-04-01 2011-04-01 2012-07-01 2012-07-01 2013-10-01 2013-10-01 2015-01 0 2015-01-01 2016-04-01 2016-04-01 2017-07-01 2017-07-01 2018-10-01 2018-10-01 2020-01 01 2020-01-01

1.2

a

Expected inflation moves in lockstep with actual inflation, albeit at a slower pace. One argument is that actual inflation frequently includes short-term price variations (such as energy price hikes) that are not expected to endure long. The diagram looks like this:

b

Consumer Price Index for All Urban Consumers: All Items (CPIAUCSL) University of Michigan Inflation Expectation (MICH) 15.0 12.5 10.0 ! 7.5 (Percent Change from Year Ago) , 5.0 2.5 (Percent) 0.0 -2.5 1978 1983 1988 1993 1998 2003 2008 2013 2018 Shaded areas indicate US recessions. FRED 2013 research.stlouisfed.org CPIAUCSL MICH

c

The expected inflation rate is the rate at which we expect inflation to rise in the months and years ahead. This is usually determined by the rate of inflation during the previous months and years. This is how we arrive at our conclusion. This permits the economy to prepare the other variables like national income and output as the inflation rate changes.

What is considered is the difference between the expected and actual inflation rates. The Philips Curve, which is based on the predicted inflation rate, is also based on this. Because it is developed from historical actual inflation rates, the projected inflation rate will necessarily be more steady, and the standard deviation from the overall inflation data will be lower.

d

The actual inflation rates will fluctuate based on ups and downs of the economy, but the expected inflation rate will be more stable year on year.

Please see attached file