The Reagan Administration entered office in 1981 with one of the
clearest and moat ambitious agendas in recent times. The new administration
advanced five economic/budgetary goals to rebuild America economically and
militarily: (1) reduce inflation, (2) deregulate the economy, (3) cut
taxes, (4) increase military spending and (5) reduce nondefense spending
sufficiently to balance the budget. Achieving, or not achieving, these
economic/budgetary goals likely had a significant impact on interest rates.
Six specific hypotheses are investigated in this paper.
During the first Reagan term, the battle to lower inflation acted to
maintain the high real interest rates carried over from the Carter years
and, while the increase in structural deficits did not raise real rates
much, the reduction in private saving due to the unwinding of the second
OPEC shock and an aggressive foreign policy that heightened fear of nuclear
war raised real interest rates to levels not seen since the late 1920s.
Moreover, the increased volatility of interest rates during this protracted
battle with inflation raised yields on callable fixed-rate mortgages by over
a percent'age point relative to the already inflated yields on noncallable
By the end of Reagan's second term, inflation, marginal tax rates,
nuclear fear, and interest rate volatility were all down. As a result,
nominal Treasury rates have plunged (real bill rates since 1986 are below
their average values for the previous quarter century), and yields on
callable securities have receded to more normal levels relative to
noncallable Treasuries. Yields on tax-exempt securities are one and a
quarter percentage points higher relative to Treasuries than in the pre-
Reagan years, and yields on fixed-rate mortgages are up by a half percentage
point. These constitute an intended reduction in the previous financial
subsidies to state and local and household capital formation, respectively.
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