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THE BEHAVIOR OF U.S. SHORT-TERM INTEREST RATES SINCE OCTOBER 1979

Authors

  • RICHARD H. CLARIDA,

  • BENJAMIN M. FRIEDMAN

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    • Yale University and Harvard University, respectively, and National Bureau of Economic Research. We are grateful to Diane Coyle for research assistance; to her, as well as Takatoshi Ito, Christopher Sims, and especially Mark Watson for helpful discussions and suggestions; and to the National Science Foundation (grant SES81–2673) and the Alfred P. Sloan Foundation for research support.

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, underpredict short-term interest rates during this period. Although a nonstructural 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 interest rates. 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.

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