§7. Short Term Interest Rates and Prices in the United States

A study of short term commercial paper rates in relation to short term price movements corroborates the evidence obtained from correlating long term interest rates and price changes. The New York interest rates on short term commercial paper have been correlated with changes in the quarterly wholesale price indexes computed from monthly indexes of the United States Bureau of Labor Statistics for the periods 1890-1914 and 1915-1927.58

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On Chart 49 are plotted the curves showing the quarterly price indexes and the P' and P' derived from them, with the interest rates for the entire period 1890-1927. P' is shown for 120 quarters or 30 years.

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These curves of quarterly data tell much the same story as is told by the curves representing yearly data, shown in Chart 48, for Great Britain. P' obviously corresponds much more closely to i than does P'.

Chart 50 shows the rather erratic variation of the r's computed from i and P' directly without distributing the effects of price changes.

Correlation Coefficients Between P' and i: for Various Lags, Quarterly Data, United States, 1890-1927.

Chart 51, on the contrary, shows, in sharp contrast, the steady increase in r computed from i and price changes with influence distributed over periods from 20 to 120 quarters. This chart shows that, in the period 1915-1927, r reaches its maximum (+0.738) only when a total of 120 quarters, or 30 years, is included in the period subject to the influence of price changes upon i.

Correlation Coefficients Between and i for Various Distributions of Lags. is the Combined Effect at Any Point of Time of the Influence of Preceding P' 's with Lags Distributed. Quarterly Data, United States, 1890-1927.

The studies of both the long term and short term movements of prices and interest rates give very similar results. In both studies the r's are insignificant when P' and i are correlated directly, either with or without lagging, so long as we ignore the fact that the effects Edition: current; Page: [428] of price changes are distributed over many years. But when the effects of price changes are distributed, the r's take on an entirely different aspect with an entirely new meaning, especially during the War period when prices fluctuated widely and quickly. It would seem then that price and interest fluctuations are governed by one law, not, as has been suggested, by two different opposing laws, for short and for long periods of time.

It seems fantastic, at first glance, to ascribe to events which occurred last century any influence affecting the rate of interest today. And yet that is what the correlations with distributed effects of P' show. A little thought should convince the reader that the effects of bumper wheat crops, revolutionary discoveries and inventions, Japanese earthquakes, Mississippi floods, and similar events project their influence upon prices and interest rates over many future years even after the original casual event has been forgotten.59 The skeptical reader need only be reminded that the economic effects Edition: current; Page: [429] on the farmer of the deflation of 1920 are now, in 1929, sufficiently acute to make farm relief a pressing political problem and that these economic effects may be expected to persist for many years to come. A further probable explanation of the surprising length of time by which the rate of interest lags behind price change is that between price changes and interest rates a third factor intervenes. This is business, as exemplified or measured by the volume of trade. It is influenced by price change and influences in turn the rate of interest.