8.1 Supply and Demand for Loanable Funds
193
Historical Changes in U.S. Interest Rate Levels
Interest rates for loanable funds have varied throughout the history of the United States as the
result of shifting supply and demand. Since just after the Civil War,
there have been four peri-
ods of rising or relatively high long-term interest rates and four periods of falling or relatively
low interest rates on long-term loans and investments.
Periods of increasing or high long-term interest rates were as follows:
• 1864–1873
• 1905–1920
• 1927–1933
• 1946–1982
The rapid economic expansion after the Civil War caused the fi rst period of rising interest
rates, from 1864 to 1873. The second period, from 1905 to 1920, was based on both large-
scale prewar expansion and the infl ation associated with World War I.
The third period, from
1927 to 1933, was due to the economic boom from 1927 to 1929 and the unsettled conditions
in the securities markets during the early part of the Great Depression, from 1929 to 1933. The
rapid economic expansion following World War II led to the last period, from 1946 to 1982.
Periods of decreasing or low long-term interest rates were, as follows:
• 1873–1905
• 1920–1927
• 1933–1946
• 1982–present
The fi rst period of falling interest rates was from 1873 to 1905.
As the public debt was
paid off and funds became widely available, the supply of funds grew more rapidly than the
demand for them. Prices and interest rates fell, even though the economy was moving forward.
The same general factors were at work in the second period, 1920 to 1927.
The third period of
low interest rates, from 1933 to 1946, resulted from the government’s actions in fi ghting the
Great Depression, and continued during World War II, when interest rates were pegged, or set.
Beginning in 1966, interest rates entered
a period of unusual increases, leading to the
highest rates in U.S. history. This increase in rates began as a result of the Vietnam War. It
continued in the 1970s because of a policy of on-again, off -again price controls and increased
demands for capital arising from ecological concerns and the energy crisis. Furthermore,
several periods of poor crops coupled with sharp price increases
for crude oil caused world-
wide infl ation. Interest rates peaked at the beginning of the 1980s, with short-term rates
above 20 percent and long-term rates in the high teens. In summary, double-digit infl ation,
a somewhat tight monetary policy, and heavy borrowing demand by business contributed to
these record levels.
The fourth period of declining long-term interest rates began in 1982,
when rates peaked,
and continues today. Infl ation rates dropped dramatically from double-digit levels during the
beginning of the 1980s to below 3 percent since the early 1990s. Low infl ation rates, generally
in the 2 to 3 percent range, have continued through 2015. The decline in infl ation rates seems
to have been a primary reason long-term interest rates have also trended downward.
Short-term interest rates generally move up and down with the business cycle. Therefore,
they show many more periods of expansion and contraction. Both
long-term and short-term
interest rates tend to rise in prosperity periods during which the economy is expanding rapidly.
A major exception was during World War II, when interest rates were pegged. During this
period the money supply increased rapidly, laying the base for postwar infl ation.
Today, both short-term and long-term interest rates are at or near historical lows in the
United States.
This has been due, in part, to the Fed’s eff orts to avoid a fi nancial meltdown
during the 2007–08 fi nancial crisis and to support economic recovery from the 2008–09 Great
Recession. Recall from Chapter 4 that the Fed reacted by employing nontraditional monetary
policy actions called quantitative easing. QE1 was implemented in 2008, QE2 began in 2010,
and QE3 was initiated in 2012. In December 2015, the Fed initiated a change in monetary
policy by raising its federal funds rate target from 0.00-0.25 percent to 0.25-0.50 percent.
