The International Linkage of Real Interest Rates: The European - U.S. Connection

Casual observation indicates that in recent years real interest rates in the United States appear to have risen sharply and have remained high relative to historical standards. Many observers have claimed that these high real rates have been transmitted abroad and have lead to high real rates in the rest of the industrialized countries. Concern over the level of real rates has been widespread in the analyses by economic policymakers both in Europe and in the United States. In this paper we present evidence on several questions regarding the movement in short term real interest rates in eight countries that have been raised by the recent policy debates in Europe and the United States: Have ex ante real rates in the United States and Europe been high during recent years? Has there been a link between U.S. real rates and those in other countries? Can this link be quantified?The basic finding in this paper is that real rates have climbed dramatically from the 1970s to the 1980s in both the European countries and the United States. Indeed, real interest rates in the United States are currently at high levels unprecedented in the post war period, which rival the levels that occurred during the Great Depression. Complaints that real interest rates in the United States are exceedingly high seem to be well justified. There is also strong evidence that there is a positive association between movements in U.S. real rates and those in Europe. However,European real rates typically do not move one-for-one with U.S. real rates,still leaving open the possibility that European monetary policy can influence domestic economic activity.