Working Paper: NBER ID: w1273
Authors: Richard H. Clarida; Benjamin M. Friedman
Abstract: Short-term interest rates in the United States have been "too high" since October 1979 in the sense that both unconditional and conditional forecasts, based on an estimated vector autoregression model summarizing the prior experience,under predict short-term interest rates during this period. Although a non-structural model cannot directly answer the question of why this has been so,comparisons of alternative conditional forecasts point to the post-October 1979 relationship between the growth of real income and the growth of real money balances as closely connected to the level and pattern of short-term interestrates. This finding is consistent with the authors' earlier conclusion, based on analysis of a small structural macroeconometric model, that the high average level of interest rates has been due to a combination of slow growth of (nominal)money supply and continuing price inflation, which together have kept real balances small in relation to prevailing levels of economic activity.
Keywords: short-term interest rates; macroeconomic analysis; vector autoregression; money supply; inflation
JEL Codes: E43; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| high levels of interest rates (E43) | low real balances relative to economic activity (E44) |
| real income growth + real money growth (O42) | short-term interest rates (E43) |
| slow growth in nominal money supply + persistent inflation (E59) | high levels of interest rates (E43) |
| growth of real income (O49) | growth of real money balances (E49) |
| growth of real money balances (E49) | short-term interest rates (E43) |