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Monetary Policy Regime Shifts and the Unusual Behavior of Real Interest Rates

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  • John Huizinga
  • Frederic S. Mishkin

Abstract

A striking phenomenon of the early 1980s is the climb in real interest rates to levels unprecedented in the post-World War II period. In order to understand this phenomenon, this paper investigates the nature and timing of shifts in the real rate process to determine if the recent unusual behavior of real rates is associated with monetary policy regime changes. We find that not only are there significant shifts in the stochastic process of real interest rates in October 1979 and October 1982 when the Federal Reserve alters its behavior, but these dates are also found to be the most likely breakpoints in the real rate process. When we analyze another monetary policy regime change with many similarities to that of October 1979, the sharp rises in the discount rate in 1920, we also reach a similar conclusion; there is a striking correspondence between the monetary policy regime change and the shift in the real rate process. Other studies have examined competing explanations for the recent unusual behavior of real interest rates -- e.g.budget deficits or favorable changes in business taxation. Although these competing explanations have met with mixed success, our evidence lends substantial support to the view that monetary policy regime changes have been and continue to be an important source of shifts in the behavior of real interest rates.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1678.

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Date of creation: Aug 1985
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Publication status: published as Huizinga, John & Mishkin, Frederic S., 1986. "Monetary policy regime shifts and the unusual behavior of real interest rates," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 24(1), pages 231-274, January.
Handle: RePEc:nbr:nberwo:1678

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  1. Fama, Eugene F, 1976. "Inflation Uncertainty and Expected Returns on Treasury Bills," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 84(3), pages 427-48, June.
  2. Evans, Paul, 1985. "Do Large Deficits Produce High Interest Rates?," American Economic Review, American Economic Association, American Economic Association, vol. 75(1), pages 68-87, March.
  3. Robert J. Barro, 1984. "The Behavior of U.S. Deficits," University of Chicago - George G. Stigler Center for Study of Economy and State, Chicago - Center for Study of Economy and State 32, Chicago - Center for Study of Economy and State.
  4. Mascaro, Angelo & Meltzer, Allan H., 1983. "Long- and short-term interest rates in a risky world," Journal of Monetary Economics, Elsevier, Elsevier, vol. 12(4), pages 485-518, November.
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