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. The 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.
