Presentation on theme: "Economic Cycle Economic Cycle = one complete movement from peak to peak (or trough to trough) Peak = height of economic prosperity. Contraction ="— Presentation transcript:
Economic Cycle Economic Cycle = one complete movement from peak to peak (or trough to trough) Peak = height of economic prosperity. Contraction = downturn in the economy. Expansion = period of positive economic growth. Recession = period when national economic growth is negative for 2 or more consecutive quarters. Trough = lowest point in the cycle.
Four Stages of an Economic Cycle Examples of historical cycles (trough to trough): 1959-1969, 1969-1975, 1975-1980, 1980-1989, 1989-1991, 1991-2001
Long-Term and Short-Term Interest Rates What is “short term” and what is “long term?” Short Term: U.S. T-Bills (week of 8/25/2014) A short-term debt obligation backed by the U.S. government with a maturity of less than one year. T-bills are sold in denominations of $1,000 up to a maximum purchase of $5 million and commonly have maturities of one month (four weeks), three months (13 weeks) or six months (26 weeks). 3-month0. 03 6-month0.05 1-year0.11 Source: http://www.bankrate.com/rates/interest- rates/treasury.aspx?ec_id=m1104673&s_kwcid=AL!1325!3!41196774248!b!!g!!t%20bill s%20rates&ef_id=U34K@wAABM1eYh-I:20140827164616:s
Long-Term and Short-Term Interest Rates Longer-Term Investments: U.S. Treasury Bonds... A marketable, fixed-interest U.S. government debt security with a maturity of more than 10 years. Treasury bonds make interest payments semi-annually and the income that holders receive is only taxed at the federal level. Time Period 08/14 Interest Rate 10-year2.41 Interest rates on long-term investments can be thought of as the average of future short-term rates expected by investors. http://www.bankrate.com/rates/interest- rates/treasury.aspx?ec_id=m1116962&s_kwcid=AL!1325!3!41196780848!p!!g!!treasury%20bonds %20rates&ef_id=U34K@wAABM1eYh-I:20140827164934:s
The Spread - The difference between long- term and short-term interest rates. Source: Board of Governors of the Federal Reserve.
What does the difference between long-term and short-term interest rates tell us? Large positive difference (i.e., long- term r minus short-term r is positive and large) investors think that interest rates will rise in the future short-term interest rates will rise at a faster pace than long-term interest rates
What does the difference between long-term and short-term interest rates tell us? Large negative difference (i.e., long- term r minus short-term r is negative and large) investors think that interest rates will fall in the future short-term interest rates will fall at a faster pace than long-term interest rates fall
Since 1975... In all instances where the spread was negative, interest rates subsequently fell. The more negative the spread, the bigger the decline in interest rates that occurred. In instances where there were large positive spreads, interest rates subsequently rose.
Other info the difference between long-term and short-term interest rates gives us... The spread tells us something about what is likely to happen to national economic growth in the near future. Important information regarding forecast for future employment Important information regarding what is likely to happen to financial markets and interest rates Important information regarding future inflation
Making Economic Forecasts Why do families and households care about economic forecasts? Implications for the costs of borrowing Implications for the benefits of saving Implications for the mix of human, physical, and financial capital families should hold Implications for risk management
What indicators can/do help families make accurate forecasts? Business cycle information - i.e., what is happening to real national economic growth. Where have we been recently? Recent rates of inflation (look to CPI) The spread between long- and short- term interest rates (comparison between 10-yr bonds and 3-6 month T-bills)