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December 1984

Real Interest Rates: What Accounts for Their Recent Rise?

by A. Steven Holland

The author estimates both short- and long-term real interest rates and shows that they have been higher during the 1980s than in the previous two decades. Most of this upward movement in real rates occurred during late 1980 and early 1981. He then examines several possible factors that affect real interest rates to see if they have played a major role in the shift to higher rates. He finds that an increase in the variability of money growth, which increased economic uncertainty and the risk premium on interest rates, was most closely coincident with the rise in real rates. Other potential factors, such as the major changes in current and projected government deficits and in tax policies, which many analysts blame for the real interest rate rise, took effect after most of the upward shift in real interest rates already had occurred.