D32ogoqmya1dw8.cloudfront.net



Activity Handout

Nominal and Real Interest Rates

Author

Diego Mendez-Carbajo, Department of Economics, Illinois Wesleyan University

dmendez@iwu.edu

Step-By-Step Activity Description

The user of the FRED database will take the following steps in order to quantify the concept of nominal and real interest rates.

(Step 1)

The user will first generate a graph of the 30-Year Conventional Mortgage Rate (MORTG) (Category: Money, Banking & Finance > Interest Rates > Mortgage Rates)

(Step 2)

The user will then “Add a Data Series > Add New Series”, graphing the Consumer Price Index for All Urban Consumers (CPIAUCSL) (Category: Prices > Consumer Price Indexes > Consumer Price Index for All Urban Consumers: All Items)

Note: The user should “Edit Data Series 2 > Units” and select “Percent Change From Year Ago”, transforming the Consumer Price Index into the CPI Inflation Rate allows for both series to be plotted in the same units.

(Step 3)

The user will then “Edit Data Series 2” (Consumer Price Index for All Urban Consumers (CPIAUCSL)) by deleting it [click on trash can icon to the right of the series’ name].

Next, the user will “Add a Data Series > Modify Existing Series > Data Series 1”, graphing the Consumer Price Index for All Urban Consumers (CPIAUCSL) (Category: Prices > Consumer Price Indexes > Consumer Price Index for All Urban Consumers: All Items)

Note: As before, the user should “Edit Data Series 1 > (b) CPIAUCSL > Units” and select “Percent Change From Year Ago”. Transforming the Consumer Price Index into the CPI Inflation Rate allows for both series to be plotted in the same units.

These steps are needed in order to have both series as part of the same database object and allow for their manipulation. This manipulation is accomplished by selecting “Create Your Own Data Transformation > Formula > a – b > Apply”

The graph now plots the difference between the nominal interest rate on conventional 30-year mortgages and the inflation rate, a computation of the real interest rate on conventional 30-year mortgages.

(Step 4)

Last, the user will add the 30-Year Conventional Mortgage Rate (MORTG) (Category: Money, Banking & Finance > Interest Rates > Mortgage Rates) to the graph by “Add a Data Series > Add New Series”. This way the nominal and the real interest rate can be directly compared.

Suggested Discussion Questions

• How did the real cost of a mortgage during the 2001-2008 expansion compare to the real cost of a mortgage during the 1991-2000 expansion? What are the implications of low real interest rates for real estate markets?

• How did the nominal cost of a mortgage change during the 2008-2009 financial crisis? How did the real cost of a mortgage change during the 2008-2009 financial crisis? How can you explain that difference? What are the implications of high real interest rates for real estate markets?

Further Sophistications

• Plot the difference between the Effective Federal Funds Rate (FEDFUNDS) and the growth rate of the Consumer Price Index for All Urban Consumers (CPIAUCSL). Compare with the previous graph. Discuss how the monetary policy target drives the cost of borrowing and where the monetary policy target, in real terms, stands today.

................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download