High interest rates and inflation in the U.S.: cause or effect?

Abstract

The paper analyses three related aspects of the U.S. interest rate experience in the 1960s: the underlying factors responsible for the extraordinary rise in interest rates in the 1960s, the stickiness of long rates during the 1969-1970 recession and its relation to the stock prices decline, and the interest rate movements in the recovery starting in 1970. The author first reviews the interest developments in the 1960s, during the 1969-1970 recession, and since the 1970 recovery. The real and the nominal theories and their implications for the cause and effect relation between inflation and interest rates are then summarised. The relations among real rates of return and between the real and nominal interest rates and their responses to changes in the natural rate and “equivalent” changes in the inflation are then analysed. Finally, the neo-Keynesian model of capital boom, tight money, and high real rates and inflation is elaborated, and the monetarist scenario of easy money, inflationary expectations, tight credit, and high nominal rates is developed.

JEL: E31, E43