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Corporate bond interest rates are a good measure of the interest rate facing firms planning investments. Before the financial crisis, this rate was...

1. Corporate bond interest rates are a good measure of the interest rate facing firms planning investments. Before the financial crisis, this rate was about 2% higher than the fed funds rate. At the peak of the crisis in October 2008, the Baa rated bond rate was almost 9 percent higher than the fed funds rate.


a) Go to the FRED database and look up the series BAA10Y and extend the data range to "max". Compare what you see to the TED spread TEDRATE for the same range. Find the definitions for each of these interest rate spreads. Why do you think these two measures are often used to discuss financial conditions in the macroeconomics?


b) Suppose the economy begins in steady state, and there is a shock to the interest spread f. Use the IS-MP and AS/AD diagrams to show and explain how the economy reacts if the Fed follows the simple monetary rule does not change its inflation target.


c) Continuing from part b), explain how the economy adjusts back towards the steady state when the shock to f lasts for one period.

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