Why Have Short-Term Interest Rates Been So High?

Abstract

THE most visible and persistent feature of the U.S. financial markets thus far during the 1980s has been high interest rates. Observed nominal interest rates on most instruments traded in the U.S. debt markets have set record highs twice since 1980. Perhaps more important, interest rates, in the sense of observed nominal rates less a presumed expectation of future price inflation, have been unprecedentedly high as well. During the past few years nominal interest rates first rose to levels far above the prevailing inflation rate, and more recently the decline in nominal interest rates has lagged well behind the slackening pace of inflation. Especially for instruments of short maturity, for which inferences about expectations of inflation in the distant future are not necessary, these high nominal interest rates have clearly corresponded to high real rates as well. Although the rough dimensions of this development are broadly familiar, it may be helpful to recall just how sizable these interest rate movements have been. The three-month U.S. Treasury bill rate, for example, was 11.60 percent on average during the fifteen calendar quarters beginning in 1979:4 (when the Federal Reserve System announced its new monetary policy) and extending through mid-year 1983.