Date of Award

6-2012

Document Type

Open Access

Degree Name

Bachelor of Arts

Department

Economics

First Advisor

Eshragh Motahar

Language

English

Keywords

federal reserve, interest rates, economic growth, economics

Abstract

The Federal Reserve has been highly active in the past decade in its attempts to lower long-term interest rates and spur economic growth. This thesis will investigate how the Federal Reserve’s actions have influenced long-term Treasury yields and whether the manipulation of the long-term interest rate helps stimulate economic growth through capital investment. To examine how the Fed’s actions affect long-term yields we study the maturity composition of the Fed’s Open Market Operations (OMOs). As the trend of proportional purchases shift farther out along the yield curve, we expect the long-term interest rate to decrease. The impact of shifting long-term interest rates on economic growth will be examined through its influence upon capital investment. An altered version of Chirinko’s (1993) Neoclassical Investment Model is used to demonstrate this relationship. The key explanatory variables of this investment model are output and the user cost of capital. The determination of the user cost of capital includes interest rates, which is the channel through which we will test the impact of differing interest rates on capital investment. We find that the Federal Reserve is successful in lowering the long-term interest rate through its Quantitative Easing and Operation Twist programs. We also find that total capital investment increases by 2.9% in response to a 1-percentage point reduction in the 10-year interest rate on average.

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