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

2. 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

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

4. Correlogram for FFRCorrelogram for Unemployment

5. 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-3.230898 1% Critical Value*-3.4432 5% Critical Value-2.8665 10% Critical Value-2.5694 ADF Test Statistic-1.543935 1% Critical Value*-3.4432 5% Critical Value-2.8664 10% Critical Value-2.5694 FFR - only at 1% level Unemployment rate

6. Differenced Time Series

7. Correlogram of differenced FFR Correlogram of differenced unemployment rate

8. Unit Root Test dFFR dUnemployment rate ADF Test Statistic-8.295159 1% Critical Value*-3.4432 5% Critical Value-2.8665 10% Critical Value-2.5694 ADF Test Statistic-16.43205 1% Critical Value*-3.4432 5% Critical Value-2.8665 10% Critical Value-2.5694

9. Univariate ARMA Output

10. Correlogram of Residuals dFederal Funds RatedUnemployment Rate

11. Correlogram of Residauls Squared dFederal Funds RatedUnemployment Rate

12. ARCH LM Test dFederal Funds RatedUnemployment Rate

13. ARCH GARCH Model dFederal Funds RatedUnemployment Rate

14. Actual Fitted Residual Graphs dFederal Funds RatedUnemployment Rate

15. Correlogram of Residuals dFederal Funds RatedUnemployment Rate

16. Correlogram of Residuals Squared dFederal Funds RatedUnemployment Rate

17. Forecasts of Univariate Models

18. 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?

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

20. Granger Causality Test Pairwise Granger Causality Tests Date: 05/31/07 Time: 15:10 Sample: 1954:07 2007:12 Lags: 24 Null Hypothesis:ObsF-StatisticProbability DFEDFUNDS does not Granger Cause DUNEMPLOYMENT 609 2.14998 0.00129 DUNEMPLOYMENT does not Granger Cause DFEDFUNDS 2.94100 4.7E-06 Both variables are significant, however the unemployment rate is more significant

21. Summary of Significant Lags of Vector Autoregressive Estimates

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

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

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

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

26. VAR Forecast May 07 – Dec 07

27. VAR forecast of May 07 – Dec 07

28. Forecast Comparison

29. Questions?