Project II Troy Dewitt Emelia Bragadottir Christopher Wilderman Qun Luo Dane Louvier

Scope of analysis Does monetary policy affect the U.S. Economy? What is going to be the status of U.S. economy upon graduation – will we be able to get a job? Will inflationary pressures force the Federal Reserve to raise the interest rate? Use univariate model to forecast the federal fund rates Use univariate model to forecast the unemployment rate If causality exists between the two variables use a VAR model to forecast the data

Trace Unemployment Rate and Federal Funds Rate - It appears that changes in the unemployment rate lag changes in the federal funds rate

Correlogram for FFRCorrelogram for Unemployment

Both time series have a unit root – Meaning we have to difference the data to eliminate the data’s dependence on time ADF Test Statistic % Critical Value* % Critical Value % Critical Value ADF Test Statistic % Critical Value* % Critical Value % Critical Value FFR - only at 1% level Unemployment rate

Differenced Time Series

Correlogram of differenced FFR Correlogram of differenced unemployment rate

Unit Root Test dFFR dUnemployment rate ADF Test Statistic % Critical Value* % Critical Value % Critical Value ADF Test Statistic % Critical Value* % Critical Value % Critical Value

Univariate ARMA Output

Correlogram of Residuals dFederal Funds RatedUnemployment Rate

Correlogram of Residauls Squared dFederal Funds RatedUnemployment Rate

ARCH LM Test dFederal Funds RatedUnemployment Rate

ARCH GARCH Model dFederal Funds RatedUnemployment Rate

Actual Fitted Residual Graphs dFederal Funds RatedUnemployment Rate

Correlogram of Residuals dFederal Funds RatedUnemployment Rate

Correlogram of Residuals Squared dFederal Funds RatedUnemployment Rate

Forecasts of Univariate Models

Causality Does the unemployment rate Granger cause the federal funds rate? Does the federal funds rate Granger cause the unemployment rate? Is there two-way causality between these two variables?

Cross Correlogram: Differenced Unemployment Rate and Differenced Federal Funds Rate (Evidence of Two-Way Causality)

Granger Causality Test Pairwise Granger Causality Tests Date: 05/31/07 Time: 15:10 Sample: 1954: :12 Lags: 24 Null Hypothesis:ObsF-StatisticProbability DFEDFUNDS does not Granger Cause DUNEMPLOYMENT DUNEMPLOYMENT does not Granger Cause DFEDFUNDS E-06 Both variables are significant, however the unemployment rate is more significant

Summary of Significant Lags of Vector Autoregressive Estimates

Impulse Response VAR Estimates (Unemployment appears to have significant effects on the Federal Funds rate for five months)

Impulse Response VAR Estimates (Federal Funds rate has an insignificant effect on the unemployment rate)

Test of the models ability to accurately forecast Apr 06 – Apr 07

Test of the models ability to accurately forecast Apr 06 – April 07

VAR Forecast May 07 – Dec 07

VAR forecast of May 07 – Dec 07

Forecast Comparison

Questions?