Question

Go to the St. Louis Federal Reserve FRED database, and find data on Real Private Domestic Investment (GPDIC1), a measure of the real interest rate; the 10-year Treasury Inflation-Indexed Security, TIIS (FII10); and the spread between Baa corporate bonds and the 10-year U.S. treasury (BAA10YM), a measure of financial frictions. For (FII10) and (BAA10YM), convert the frequency setting to “quarterly,” and download the data into a spreadsheet. For each quarter, add the (FII10) and (BAA10YM) series to create ri , the real interest rate for investments for that quarter. Then calculate the change in both investment and ri as the change in each variable from the previous quarter.

a. For the eight most recent quarters of data available, calculate the change in investment from the previous quarter, and then calculate the average change over the eight most recent quarters.

b. Assume there is a one-quarter lag between movements in ri and changes in investment; in other words, if ri changes in the current quarter, it will affect investment in the next quarter. For the eight most recent lagged quarters of data available, calculate the onequarter-lagged average change in ri .

c. Take the ratio of your answer from part (a) divided by your answer from part (b). What does this value represent? Briefly explain.

d. Repeat parts (a) through (c) for the period 2008:Q3 to 2009:Q2. How do financial frictions help explain the behavior of investment during the financial crisis? How do the coefficients on investment compare between the current period and the financial crisis period? Briefly explain.

Short answer

a. The average change in investment is 2.18%

b. The average change in r is -14.08%.

c. The ratio of two averages is 0.14.

d. The average change in investment is 8.98%. The average change in r is 0.22%. The ratio of two averages is 40.81.

Step-by-step solution

Step 1. Introduction

The information obtained from the federal reserve database is given below:

observation_date	GPDIC1	FII10	BAA10YM	r
2007-10-01	2653.056	1.92	2.25	4.17
2008-01-01	2583.253	1.32	3.09	4.41
2008-04-01	2536.403	1.48	3.10	4.59
2008-07-01	2485.549	1.70	3.34	5.04
2008-10-01	2246.441	2.60	5.59	8.19
2009-01-01	1986.845	1.79	5.48	7.27
2009-04-01	1872.287	1.72	4.67	6.39
2009-07-01	1868.013	1.74	3.14	4.89
2009-10-01	2040.736	1.37	2.87	4.24
2010-01-01	2087.171	1.43	2.57	4.00
2010-04-01	2196.706	1.36	2.69	4.04
2010-07-01	2294.672	1.06	2.99	4.05
2010-10-01	2287.362	0.75	3.05	3.80
2011-01-01	2244.241	1.09	2.63	3.72
2011-04-01	2336.057	0.80	2.64	3.44
2011-07-01	2343.786	0.28	3.04	3.32
2011-10-01	2524.429	0.05	3.21	3.26
2012-01-01	2577.157	-0.17	3.16	3.00
2012-04-01	2636.495	-0.35	3.27	2.92
2012-07-01	2648.459	-0.63	3.23	2.60
2012-10-01	2624.905	-0.76	2.87	2.11
2013-01-01	2722.778	-0.59	2.86	2.27
2013-04-01	2753.237	-0.25	2.84	2.59
2013-07-01	2859.751	0.56	2.69	3.25
2013-10-01	2870.127	0.57	2.61	3.18
2014-01-01	2838.287	0.58	2.35	2.93
2014-04-01	2958.068	0.43	2.20	2.62
2014-07-01	3018.582	0.32	2.24	2.56
2014-10-01	3021.857	0.45	2.46	2.91
2015-01-01	3127.274	0.27	2.53	2.80
2015-04-01	3136.688	0.30	2.67	2.97
2015-07-01	3130.354	0.57	3.02	3.59
2015-10-01	3092.707	0.66	3.23	3.89
2016-01-01	3079.449	0.49	3.39	3.88
2016-04-01	3063.333	0.19	2.91	3.10
2016-07-01	3069.298	0.08	2.69	2.78
2016-10-01	3147.576	0.33	2.51	2.84
2017-01-01	3137.735	0.44	2.22	2.65
2017-04-01	3192.776	0.44	2.23	2.67
2017-07-01	3240.998	0.45	2.09	2.54
2017-10-01	3278.391	0.50	1.90	2.40
2018-01-01	3346.322	0.68	1.71	2.39
2018-04-01	3352.499	0.79	1.86	2.65
2018-07-01	3430.915	0.81	1.89	2.70
2018-10-01	3449.645	1.06	2.11	3.16
2019-01-01	3503.439	0.79	2.32	3.11
2019-04-01	3525.994	0.51	2.26	2.78
2019-07-01	3535.930	0.15	2.22	2.38
2019-10-01	3477.123	0.15	2.12	2.27
2020-01-01	3430.090	-0.06	2.51	2.45
2020-04-01	2901.934	-0.48	3.22	2.74
2020-07-01	3370.975	-0.94	2.66	1.72
2020-10-01	3561.893	-0.91	2.44	1.52
2021-01-01	3541.305	-0.86	2.15	1.29
2021-04-01	3506.014	-0.79	1.96	1.17
2021-07-01	3609.693	-1.02	1.91	0.90
2021-10-01	3880.182	-1.00	1.78	0.78
Average	2898.899	0.46	2.73	3.19

Step 2. Explanation Part (a)

The average change in the investment can be shown as:

observation_date	GPDIC1	% change
2020-01-01	3430.090
2020-04-01	2901.934	-15.3977
2020-07-01	3370.975	16.16305
2020-10-01	3561.893	5.663584
2021-01-01	3541.305	-0.57801
2021-04-01	3506.014	-0.99655
2021-07-01	3609.693	2.957176
2021-10-01	3880.182	7.493407
Average	3475.261	2.186418

So, the average change over the last eight recent quarters is 2.18 percent.

Step 3. Explanation Part (b)

The table below shows data on real interest rate for the eight recent quarters.

r	% change
2.45
2.74	11.97279
1.72	-37.181
1.52	-11.6054
1.29	-15.3173
1.17	-9.30233
0.90	-23.3618
0.78	-13.3829
Average	-14.0254

So,from above the average change over the eight recent quarters is 14.02%.

Step 4. Explanation Part (c)

The ratio for the two averages can be obtained as follows:

$\frac{2.08}{14.02}=0.14$

Step 5. Explanation Part (d)

For the period 2008:Q3 to 2009:Q2, the change in investment from previous quarter is given below:

observation_date	GPDIC1	% change
2008-07-01	2485.549
2008-10-01	2246.441	-9.61993
2009-01-01	1986.845	-11.5559
2009-04-01	1872.287	-5.76582
Average	2147.781	-8.98054

The average change is a decline of 8.98%.

The table below shows the percentage changes in r between 2008:Q3 to 2009:Q2.

observation_date	r	% change
2008-07-01	8.19
2008-10-01	7.27	-11.2739
2009-01-01	6.39	-12.1101
2009-04-01	4.89	-23.4864
Average	6.6825	0.225109

So, the average change in r is 0.22%.

The ratio of two averages can be obtained as,

$=\frac{8.98}{0.22}=40.81$

The data obtained from fred shows the during the financial crisis period, the value of BAA10YM which indicates financial frictions was high. This means that because of increase financial friction, the rate of investment was declining and reduction in interest rates was not able to significantly boost investment.

From the given data, it shows that during the financial crisis period the investment on an average declined by 8.98% while the interest was declining as well. THough the average change in interest rate was -0.22% in the period of four quarters. In the recent period, the change in investment has mostly remained positive. Though the affect of pandemic can be seen in certain quarters where the investment fell. The rate of interest on an average has shown significant percentage change. The ratio of the two averages show that a major change in r is causign only a small change in investment.