The Behavior of U.S. Short-Term Interest Rates Since 1979-10

Short-term interest rates in the United States have been "too high" since 1979-10 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 non-structural model cannot directly answer the question of why this has been so, comparisons of alternative conditional forecasts point to the post-1979-10 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' macroeconomic 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.