Working Paper: NBER ID: w3036
Authors: Patric H. Hendershott; Joe Peek
Abstract: As is widely recognized, real interest rates in the early 1980s were at peaks not witnessed since the late 1920s. Less well perceived is the sharp decline in real interest rates since 1984. By 1986-88, real interest rates were back at their average levels of the previous quarter century. This paper seeks to identify the underlying determinants of the major movements in real six-month Treasury bill rates. \nThe rise in real interest rates between the middle 1970s and early 1980s, not surprisingly, results from a variety of factors. First, rates were unusually low in the middle 1970s owing to the first OPEC shock, which lowered investment demand and increased world saving by transferring wealth from the high-consuming developed countries to OPEC. Second, tight money, high inflation, and heightened nuclear fear all contributed to real rates becoming unusually high in the early 1980s. The eventual decline of OPEC surpluses following the second OPEC shock prolonged the period of high real rates. The decline in real rates to more normal levels in the 1986-88 period is also due to multiple factors: lower inflation, declining marginal tax rates, and easy monetary policy.
Keywords: real interest rates; treasury bill rates; OPEC shocks; monetary policy; inflation
JEL Codes: E43; E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| low rates in the mid-1970s (E65) | rise in real interest rates from the mid-1970s to the early 1980s (E43) |
| first OPEC shock (N72) | low rates in the mid-1970s (E65) |
| first OPEC shock (N72) | reduced investment demand (E22) |
| first OPEC shock (N72) | increased world saving (E21) |
| tight monetary policy (E52) | exceptionally high real rates in the early 1980s (E65) |
| high inflation (E31) | exceptionally high real rates in the early 1980s (E65) |
| nuclear fears (L94) | exceptionally high real rates in the early 1980s (E65) |
| lower inflation (E31) | decline in real rates from 1984 to 1986 (E43) |
| declining marginal tax rates (H31) | decline in real rates from 1984 to 1986 (E43) |
| easier monetary policy (E52) | decline in real rates from 1984 to 1986 (E43) |
| decline in expected inflation (E31) | reduction in real rates (E43) |
| prolonged period of monetary ease (E66) | reduction in real rates (E43) |