CHAPTER The Behaviour of Interest Rates 109 us which one of the two scenarios, panel (b) or panel (c) of Figure 5-12, is more accurate It depends critically on how fast people s expectations about inflation adjust However, recent research using more sophisticated methods than just looking at a graph like Figure 5-13 indicate that increased money growth temporarily lowers short-term interest rates (this is also indicated in Figure 5-13 in the 2000s).7 However, as you can see in the FYI box Forecasting Interest Rates, interest rate forecasting is a perilous business Forecasting Interest Rates FYI Forecasting interest rates is a time-honoured profession Economists are hired (sometimes at very high salaries) to forecast interest rates because businesses need to know what the rates will be in order to plan their future spending, and banks and investors require interest-rate forecasts in order to decide which assets to buy The media frequently report interest rate forecasts by leading prognosticators These forecasts are produced using a wide range of statistical models and a number of different sources of information One of the most popular methods is based on the bond supply and demand framework described earlier in the chapter Using this framework, analysts predict what will happen to the factors that affect the supply of and demand for bonds and then use the supply and demand analysis outlined in the chapter to come up with their interest-rate forecasts An alternative method of forecasting interest rates makes use of econometric models, models whose equations are estimated with statistical procedures using past data Many of these econometric models are quite large, involving hundreds and sometimes over a thousand interlocking equations They produce simultaneous forecasts for many variables, including interest rates, under the assumption that the estimated relationships between variables not change over time Good forecasts of future interest rates are extremely valuable to households and businesses, which, not surprisingly, would be willing to pay a lot for accurate forecasts Unfortunately, forecasting interest rates is a perilous business To their embarrassment, even the top experts are frequently far off in their forecasts See Lawrence J Christiano and Martin Eichenbaum, Identification and the Liquidity Effect of a Monetary Policy Shock, in Business Cycles, Growth, and Political Economy, ed Alex Cukierman, Zvi Hercowitz, and Leonardo Leiderman (Cambridge, Mass.: MIT Press, 1992), pp 335 370; Eric M Leeper and David B Gordon, In Search of the Liquidity Effect, Journal of Monetary Economics 29 (1992): 341 370; Steven Strongin, The Identification of Monetary Policy Disturbances: Explaining the Liquidity Puzzle, Journal of Monetary Economics 35 (1995): 463 497; Adrian Pagan and John C Robertson, Resolving the Liquidity Effect, Federal Reserve Bank of St Louis Review 77 (May June 1995): 33 54; and Ben S Bernanke and Illian Mihov, Measuring Monetary Policy, Quarterly Journal of Economics 63 (August 1998): 869 902