From the text Web site, get Bernanke and Kuttner's data on expected and unexpected changes in the federal funds rate by the FOMC. (You may have used these data to solve Problem) Choose one day when the expected change in the funds rate was large and the unexpected change was small, and one day when the opposite was true. Then link to the site of the Federal Reserve Bank of St. Louis, which has daily data on the interest rate on 1-year Treasury bonds. For each of the days you selected from the Bernanke-Kuttner data, compute the change in the 1-year interest rate from the day before the FOMC's action to the day after the action. If you can, explain why the change in the 1-year rate was larger in one case than in the other.
Problem
The text Web site contains data from the Bernanke-Kuttner paper on the Fed and the stock market (see p. 63). The data cover 68 days from 1995 through 2002 when the Fed either changed interest rates or decided not to change them. For each of these days, the data include the change in a short-term interest rate and the percentage change in stock prices. The data also include the interest rate change that participants in financial markets expected before the Fed acted. (The expected change is measured using data from futures markets, which we discuss in Chapter 5).
a. Make a graph with the change in the interest rate on the horizontal axis and the percentage change in stock prices on the vertical axis. Plot a point for each day in the data set.
b. Now compute the unexpected change in the interest rate-the actual change minus the expected change. Redo the graph in part (a) with this variable on the horizontal axis.
c. Which has a stronger effect on stock prices, the change in the interest rate or the unexpected change? Explain your finding.