Go to the St. Louis Federal Reserve FRED database, and find data on the M1 money supply (M1SL) and the 10-year U.S. treasury bond rate. For the M1 money supply indicator, adjust the units setting to "Percent Change from Year Ago," and for the 10-year treasury bond, adjust the frequency setting to "Quarterly." Download the data into a spreadsheet.
a. Create a scatter plot, with money growth on the horizontal axis and the 10-year treasury rate on the vertical axis, from 2000:Q1 to the most recent quarter of data available. On the scatter plot, graph a fitted (regression) line of the data (there are several ways to do this; however, one particular chart layout has this option built in). Based on the fitted line, are the data consistent with the liquidity effect? Briefly explain.
b. Repeat part (a), but this time compare the contemporaneous money growth rate with the interest rate four quarters later. For example, create a scatter plot comparing money growth from 2000: Q1 with the interest rate from 2001: Q1, and so on, up to the most recent pairwise data available. Compare your results to those obtained in part (a), and interpret the liquidity effect as it relates to the income, price-level, and expected-inflation effects.
c. Repeat part (a) again, except this time compare the contemporaneous money growth rate with the interest rate eight quarters later. For example, create a scatter plot comparing money growth from 2000:Q1 with the interest rate from 2002:Q1, and so on, up to the most recent pairwise data available. Assuming the liquidity and other effects are fully incorporated into the bond market after two years, what do your results imply about the overall effect of money growth on interest rates?
d. Based on your answers to parts (a) through (c), how do the actual data on money growth and interest rates compare to the three scenarios presented in Figure 11 of this chapter?