The interest rate is how much a person/entity pays to borrower money from a lender.

- Interest Rate = Price of Money
- Interest rates measure:

- They are the traffic signals of investment
- They measure time preference
- They calibrate risk
- They set investment hurdle rates
- They have a huge impact on:
- banks
- real estate market
- auto industry
- etc.
- They can fuel or crate prices of other assets like stocks and real esate

- Forecasting interest rates is extremely difficult - there are countless factors
- Some consider it to be impossible
- Central banks often try to forecast interest rates, but are proven incorrect over time

**What Determines the Interest Rates**

- Short and long term interest rates are driven by different forces
- Long-term rates are usually higher than short-term rates (more uncertainty)
- Rates can be driven by Central bank Actions
- Short term rate adjustments
- Quantitative Easing (asset purchases) to drive long-term rates
- Forward Guidance (Telling the markets what it plans to do)
- Interest rates tend to move in long-term cycles:
- 1900 - 1920 rising interest rates & inflation
- 1920 - 1946 falling rates
- 1946 - 1981 rising rates
- 1982 - 2016???? (end dates still tbd) falling rates
- Interest Rate Cycles are Natural: People first consume more than they can produce (rates go up), then later they have to pay it off (rates go down)

**What Drives Short-Term Interest Rates**

- The supply and demand for credit determines short term interest rates (liquidity effect)
- Short term interest rates are driven by the Federal Funds rate
- The further out the yield curve you go, the less influence the federal funds rate has

What Drives Long-Term Interest Rates

- Long term interest rates are driven by the markets expectations for economic growth and inflation
- Long-Term Treasury Bond Yield = Real Rate + Inflationary Expectations
- See the Fisher Equation
- Dr. Lacy Hunt Model:
- Long-term interest rates are driven by the aggregate demand for money
- Long-term interest rates are driven by the Monetary Base (MB) * the money multiplier (m) * the velocity of money (V)
- The aggregate demand is the same thing as GDP (AD = GDP)
- GDP = M2 * V
- ==> AD = GDP = M2 * V
- M2 = MB * m
- ==> AD = MB * m * V

**US Historical Interest Rate Levels (Short Term Fed Rate)**

- Rates generally rose in the 1960s and 1970s
- Rates mostly above 2.5% from 1960s to 2010
- Rates mostly above 5% in 1970s and 1980s
- Rates jumped to 10% - 19%+ in late 1970s and early 1980s
- Rates started to decline around 1980 into 2016 (end still TBD as of 2018)
- Rates at historical lows from 2010 onwards (after great recession and FED QE Programs)