A Two Year Forecast of
Interest Rates
BROOK BEASLEY
and SHANNON CANTER
College of
Business
Western
Carolina University
This paper forecasts the future of interest rates in the U.S. economy for the next two years. By examining the Loanable Funds Model and the past ten years interest rate movement, this paper will show the future of interest rates for the United States. The explanatory variables used are the U.S. money supply and interest rates. 3month Treasury Bill Interest Rates are forecast to increase approximately 78 basis points until September 2001. The forecasting results were that interest rates should remain very stable and should have nearly zero fluctuation for the next two years. (JEL: E51, E52)
This
paper forecasts 3month Treasury Bill Rates in the Secondary Market through
2002.01. The explanatory variables used
in this forecast are the 3month Treasury Bill Rates in the secondary market
and M2 money supply. This forecast is
based on the Loanable Funds Model, which explains the relationship between the
money supply and interest rates.
Interest
rates are the cornerstone of the United States economy. Interest rates are important because
consumption and investment are directly influenced by there fluctuation. Due to the short time span of this forecast
and a stable Federal Reserve policy, this forecast should be relatively
accurate.
The
rest of this paper is organized as follows:
part 2. presents the data used to forecast interest rates; part 3. presents
the theoretical basis for the approach in forecasting interest rates; part 4.
present forecasts of interest rates through 2002.1; part 5. evaluates the
importance of the forecast to the economy; and part 6. discusses conclusions
for the economic policy.
All variables are taken from the Federal Reserve Bank of St. Louis Federal Reserve Economic Data (FRED). The M2 money supply for FRED is variable M2SL. The data is seasonally adjusted, measured in billions of dollars, and reported monthly. The 3month Treasury Bill Interest Rate is FRED variable TB3MS taken from the secondary market and given as a percent discount. The 3month Treasury Bill Rate is also given monthly. The sample period for the data used is from January 1990 through January 2000. To illustrate this, a regression of Money supply was completed.
Loanable Funds Model, which revolves around
the money supply, portrays interest rate movement. The Federal Reserve controls interest rates by increasing or
decreasing the supply of money in circulation.
This forecast of interest rates is explained by the Loanable Funds
Market, which brings together savers, the suppliers of loanable funds, and
borrowers, the demanders of loanable funds.
This determines the market rate of interest. Therefore, the supply of loanable funds is a direct reflection of
the market rate of interest and the quantity of savings, with other variables
remaining constant. The banks play the
role of a financial intermediary between the Federal Reserve and consumers. The greater the interest rate, the more
consumers are rewarded for saving. The
lower the interest rates, the more consumers are willing to spend.
An
alternative approach to this forecast would be to use the Monetarist
policy. However, this forecast uses the
Loanable Funds Model and previous information on interest rates found in
FRED. This approach is much
simpler.
Monthly
interest rates will be determined two years into the future using the M2 Money
Supply from FRED. The values for
interest rates are determined using the Loanable Funds Model and the following
equation:
r_{t }=
f (r_{t2}, M2_{t2})
This
a simple model appropriate for forecasting interest rates based on the Loanable
Funds Model. The forecast should be
interpreted as current interest rates being a function of interest rates lagged
by two years and M2 money supply also lagged by two years.
The equation was forecast by an ordinary least squared regression for the periods 1990.012000.01. The Adjusted Rsquared estimated is 0.406659, which indicates approximately 40% of the variation of r is explained by variation in M2. The intercept of the forecast occurred at 0.697305, with an estimate of .562571 = 56%. The estimate of the equation is (tstatistics in parentheses):
r_{t }= .697305(.58109) + 0.30012(5.82212)r_{t2} + 0.001482(4.65023)M2_{t2}
_{ }
The Interest rate function was estimated using M2 money supply data from January 1990 and January 2000. The following is an example of this calculation using the following formula:
r_{2000.02 }=
0.6973050.30012*5.09 + 0.001482*4098.74 = 5.24
This
forecast estimates the 3month Treasury Bill Rates in the Secondary Market
through 2002.01 using the M2 money supply.
This
forecast was done for two years into the future using the above formula and is
presented in Table 1.
Table 1 Forecast 3month Treasury Bill Rates – Secondary Market 

Quarter 
Forecast 
2000.2 
5.24 
2000.3 
5.31 
2000.4 
5.37 
2000.5 
5.38 
2000.6 
5.43 
2000.7 
5.46 
2000.8 
5.51 
2000.9 
5.67 
2000.10 
5.92 
2000.11 
5.84 
2000.12 
5.90 
2001.1 
5.95 
2001.2 
5.96 
2001.3 
5.98 
2001.4 
6.06 
2001.5 
6.04 
2001.6 
6.04 
2001.7 
6.08 
2001.8 
6.06 
2001.9 
6.10 
2001.10 
6.07 
2001.11 
6.04 
2001.12 
6.04 
2002.1 
6.04 
This
forecast is favorable because interest rates rise 78 basis points over a year
and a half and then begins to decrease the remaining six months.
This
forecast is favorable for all people considering the consistency that it
predicts. Interest rates were
predicted to stay the same for the next two years. This is not a crazy idea with stable inflation and sound
economic leadership in the Federal Reserve.
If interest rates stay relatively low, the economy should experience
continual growth. With inflation held
in check, the future of the economy is very bright. This paper recommends all U.S. consumers to not shy away from the
market or a mortgage loan.
Interest rates should stay the same at a steady 6.04 percent. This is due to stable government and monetary policy. The country is in a golden age right now of technology and business. We are also experiencing very low inflation. This coupled with other successful economic factors; it appears that the future is stable and flourishing.
1). This forecast suggests that industry spend
money on lots of research and development.
With the economy and technology growing so fast it will be important to
stay ahead. The only way to do that is
to invest in the future growth.
2). The Federal Reserve has done a great job
recently with monetary policy. This
forecast recommends that it stays relatively conservative with loanable funds. The saying “don’t mess up a good thing”
would be good for the Federal Reserve to meditate on. Stable policy should help allow our economy to have proper
checks and balances on itself.
Federal
Reserve Bank of St. Louis, Federal Reserve Economic Data (FRED), http://www.stls.frb.org/fred/
(20 February 2000).
McEachern, William A.
“Economics: A Contemporary Introduction.” Cincinnati OH: Southwestern Publishing Co., 1994.