Empirical Analysis of Canadian Interest Rates Since 1970

Empirical Analysis of Canadian Interest Rates Since 1970
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Empirical Analysis of Canadian Interest Rates Since 1970
Introduction
The relationship between short-term and long-term interest rates is of interest to economists and investors because it influences the welfare of a country’s banking institution, the value of bond portfolios situated in different types of trust funds, the cost of servicing the national debt, as well as future net premium expenses on life insurance policies, among other concerns. For economists, the relationship between long-term and short-term interest rates is central to macroeconomic policy evaluation while for investors, it is critical to projecting the inflection points in an interest cycle and even hedging against far-reaching changes in interest levels. This topic is therefore worth discussing because it answers to The goal of this empirical analysis of Canadian interest rates since 1970 is to verify the with the purpose of verifying a positive correlation between the two. An empirical analysis of this kind is important because it will allow me to examine if there is a positive correlation between long and short term interest rates.
If there is a positive correlation between the two, it is possible to speculate on long term interest rates based on the current short term interest rates and so make informed decisions on future long-term investments. While a number of economists have identified differences between long and short term interest rates, a significant proportion of them also tend to generalize interest rates without making any distinction between the two. The few who identify differences between long and short term interest rates tend to do so lightly and therefore, a more thorough investigation of the positive correlation between the two interest rates is of prime importance from an investment perspective. The next section is the methodology where in addition to restating the purpose of the essay, real world data will be applied to test the expectation theory (the theory undergirding the essay). Real world data will constitute long and short term interest rates for Canada from 1970. The essay will strive to examine if the actual interest rates are consistent with the expectation theory and how well they fit into the latter. This will be followed by an explanation of my understanding of the real world data in relation to how it applies to the expectation theory.
Tied to this subsection will be a brief summary of the theory and how it can help make me make predictions and analysis. The analysis section will involve testing hypotheses and unraveling the empirical relationship between long term interest rates and short term interest rates. It will also involve analyzing identified assumptions and exploring the validity of the theory itself as relates to making predictions of future interest rates to guide investment decisions. All sources of error together with any discrepancies with the real time encountered during analysis will also be acknowledged.
Methodology
The main purpose of this paper is to conduct an empirical analysis of Canadian interest rates since 1970 with special focus on the positive correlation between long and short-term interest rates. This study is related to the Money, Banking & Financial Market section of ECO 349 class. I have a personal interest in the theoretical relationship between long and short-term interest rates and its influence on macroeconomic policy evaluation, and especially investment decisions. While the Bank of Canada has a more direct and strong hold on short-term interests as compared to long-term interests, understanding the correlation between the two can help guide future investment decisions. Besides, investment decisions tend to rely on long-term interest rates if it is difficult to adjust capital or place it into use. I was therefore inspired to do the research myself with the aim of examining how well long and short-term interest rates move. More importantly, I was personally invested in identifying ways this study’s results could help me in making future long-term investment decisions.
The study began with an online search for real world data of both long and short-term interest rates in Canada between 1970 and the present time. Long-term interest rates denote government bonds maturing in 10 years where rates are typically influenced by the fall in capital value, the risk resulting from the borrower, as well as the price charged by the lender. In all cases, long-term interest rates are implied by financial markets and capital repayment is assured by the Canadian government. On the other hand, short-term interest rates refer to 3-month treasury bills and denote the rates at which short-term lending is carried out between financial institutions (King & Kurmann, 2002). They also indicate the rate at which treasury bills are issues or traded in the financial markets. Both long and short-term interest rates are means of daily rates, calculated as percentages. The most accurate and comprehensive cross-sectional data on long and short-term interest rates was to be found in the Organization for Economic Co-operation and Development (OECD) database. The long and short-term interest rates in Canada since 1970 to 2021 are displayed in the table below:
Country

Year

Long-term Interest Rate

Short-term Interest Rate

CAN

1970

7.965833

7.453875

CAN

1971

6.945

4.569292

CAN

1972

7.225

5.098042

CAN

1973

7.528333

7.301333

CAN

1974

8.87

10.55437

CAN

1975

8.993333

8.02375

CAN

1976

9.229167

9.276542

CAN

1977

8.693334

7.492917

CAN

1978

9.235833

8.71375

CAN

1979

10.17917

11.96133

CAN

1980

12.33833

13.12896

CAN

1981

14.98917

18.37563

CAN

1982

14.43533

14.37521

CAN

1983

11.39858

9.465834

CAN

1984

12.71004

11.22208

CAN

1985

10.91183

9.596042

CAN

1986

9.145541

9.187917

CAN

1987

9.470708

8.409583

CAN

1988

9.830916

9.61

CAN

1989

9.783184

12.17675

CAN

1990

10.71762

13.02129

CAN

1991

9.449769

9.110209

CAN

1992

8.076547

6.677083

CAN

1993

7.244352

5.102958

CAN

1994

8.361641

5.487709

CAN

1995

8.161792