ECONOMIC SUMMIT COUNTRIES: THE INTEREST RATE ISSUE

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP83B00231R000200100001-1
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 12
• Document Creation Date: December 20, 2016
• Document Release Date: January 10, 2007
• Sequence Number: 1
• Publication Date: May 1, 1982
• Content Type: REPORT

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A" d"
Intelligence
Economic Summit Countries:
The Interest Rate Issue
An Intelligence Memorandum
Confidential
GI 82-10103
May 1982
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Directorate of Confidential
Intelligence
Economic Summit Countries:
The Interest Rate Issue
Information available as of 7 May 1982
has been used in the preparation of this report.
This memoramdum was prepared by
the Office of Global Issues. Comirienlis anu queries
are welcome and may be directed to the Chief.
Economic Analysis Branch, OGI
D
Confidential
GI 82-10103
May 1982
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Confidential
Summary
Continuing high US interest rates will almost certainly be a contentious
issue at the Versailles Economic Summit. Foreign leaders are pointing to
high US rates and budget deficits as causes of high interest rates and
economic stagnation in their countries. Although the effect of US rates is
being overplayed, US rates have contributed somewhat to high interest
charges in some of the Summit countries. The primary impact has been to
induce tighter monetary policies in response to capital outflows attracted
by the higher US rates.
We believe that interest charges in the Summit countries should decline
during 1982. Internal economic conditions abroad, especially the slow-
downs in inflation, should bring rates down, and any decline in US interest
rates would speed the process.
Confidential
GI 82-10103
May 1982
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Figure I
Summit Countries: Trends in Short- and Long-Term
Interest Rates
Short-term (call money)
- Long-term (government bond yields)
15 15
10
15 A -4 15
PC,/ VN 10
64 68 72 76 80
1
1960
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Interest Rate Trends During 1981, interest rates rose sharply in each of the Summit countries
except Japan, where rates fell, and Britain, where they were already high
(figure 1). By second-half 1981 both long- and short-term rates had hit
record highs in the five other Summit countries:
? West Germany's long- and short-term rates both topped 11 percent in
third-quarter 1981, matching the previous peaks of 1973 (short term) and
1974 (long term).
? The 17-percent rates on both long- and short-term money experienced in
France in third-quarter 1981 exceeded the previous highs by 4 percent-
age points.
? In Italy, rates exceeded 20 percent for the first time.
? Rates in Canadian money markets, closely linked to US rates, soared
above 20 percent for short-term credit and above 17 percent for long -
term commitments during third-quarter 1981. 25X1
In 1982, these rates have softened. By the end of the first quarter, West
German short-term interest charges were down substantially and long-term
rates down slightly; both short- and long-term rates had declined substan-
tially in the United Kingdom and Canada. In France and Italy, the
declines were much smaller. In Japan, where interest rates are relatively
low, there has been essentially no movement. Nevertheless, interest charges
remain quite high by historical standards in all of the Summit countries ex-
cept Japan, and real rates are close to record levels
25X1
Domestic Factors Some foreign leaders and commentators, notably in Canada and Western
Europe, have attributed their high interest charges to the high US rates
and budget deficits. Trends in their own economies, however, also played
important roles (tables 1 and 2).
Rates of Inflation
The pace of inflation appears to have been the key determinant of Summit
country nominal interest rates. In countries where inflation was substan-
tially higher in 1981 than in low-interest-rate years-France, Italy, and
Canada-nominal long-term interest rates were among the highest. Nomi-
nal interest rates were lower in Japan and West Germany, countries with
lower inflation. In the United Kingdom and Italy, interest rates remained
high despite a substantial drop in inflation last year. A legacy of high
inflation in those two countries ma account in part for the stickiness of in-
terest rates 25X1
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Summit Countries: Qualitative Assessments
of Pressures on Interest Rates a
Inflation
Real
Growth
Government
Budget Deficit
Monetary
Policy
US
Rates
United States
Upward
Downward
Same
Upward
Japan
Downward
Downward
Same
Same
Upward
West Germany
Same
Downward
Same
Upward
Upward
France
Upward
Downward
Upward
Downward
Upward
United Kingdom
Same
Downward
Upward
Same
Upward
Italy
Upward
Downward
Upward
Upward
Upward
Canada
Upward
Downward
Upward
Same
Upward
a Qualitative assessments of pressures on interest rates were made by
comparing trends in the various determinants of interest rates in
1981 with the trends in 1980 and in years in which interest rates were
low. As a rule, if 1981 inflation, real growth, government budget
deficits, and US interest rates were higher, these determinants were
judged to be putting upward pressure on rates; if changes in
monetary stocks were less in 1981, this factor was also judged to be
providing upward pressure. The data used in this analysis are
presented in table 2.
Budget Deficits
Rising budget deficits also seem to have contributed to the upsurge in
interest rates last year. In each of the countries except West Germany and
Japan, deficits as a proportion of GNP were substantially higher than in
periods of low interest rates; in France and Italy, moreover, the deficits in-
creased sharply. The prospect of further increases in deficits may have
placed additional upward pressure on interest rates.
Real Credit Demands
Sluggish real economic activity probably exerted downward pressure on
interest rates during the last year in all of the countries.)
Monetary Policy
Monetary policy apparently also boosted interest rates in West Germany
and Italy. In these countries, stocks of central bank money and the broadly
defined money stock (M2) grew significantly slower than in the years of low
interest rates. Moreover, monetary growth in these two countries was
slower in 1981 than in 1980. These slowdowns restricted increases in credit
availability and, while lowering inflation, kept nominal rates high and
increased real interest rates. In Japan, interest rates fell last year as money
stock growth picked up from the very low pace of 1980.
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Summit Countries: Comparison of Trends in
Interest Rates and Selected Determinants
Low Interest 1980
Years a
1981
United States
Short-term interest rates b
5.4
15.9
13.6
Long-term interest rates b
7.0
12.2
14.1
Inflation c
5.4
9.8
8.9
Real economic growth d
4.0
-0.3
0.9
Government budget deficit a
2.6
2.6
2.5
Change in money stock (M2) f
9.6
7.6
6.1
Japan
Short-term interest rates b
4.8
10.0
6.9
Long-term interest rates b
6.6
9.3
8.3
Inflation c
4.7
4.3
2.3
Real economic growth d
6.8
3.8
1.8
Government budget deficit a
3.6
4.7
4:2
Change in money stock (M2) f
18.2
6.8
10.7
Domestic-US short-term
interest rate differential s
-1.7
-5.8
-6.7
Domestic-US long-term
interest rate differential g
-0.5
-2.9
-5.8
Change in exchange rate with
dollar b
16.8
13.3
-6.2
Short-term interest rates b
4.4
9.0
10.9
Long-term interest rates b
7.3
8.6
10.0
Inflation c
4.6
5.1
4.6
Real economic growth d
3.3
-0.6
0.4
Government budget deficit e
1.7
1.9
2.6
Change in money stock (M2) f
11.1
4.5
3.7
Domestic-US short-term
interest rate differential g
-1.6
-6.9
-2.7
Domestic-US long-term
interest rate differential g
0.0
-3.6
-4.1
Change in exchange rate with
dollar h
7.6
-7.6
-14.9
Short-term interest rates b
6.7
10.9
16.1
Long-term interest rates b
8.0
13.6
16.2
Inflation c
8.1
10.9
13.3
Real economic growth d
5.0
0.2
1.5
Government budget deficit
0.6
NEGL
2.8
Change in money stock (M2) f
16.3
8.3
15.6
Domestic-US short-term
interest rate differential 8
0.5
-4.9
2.5
a Low interest years are those years in 1970-79 in which the yearend
interest rates were below the average for the decade.
b Yearend quotes.
e Percent change in GNP deflator, fourth quarter to fourth quarter.
d Percent change in real GNP, fourth quarter to fourth quarter.
e Calendar year deficit as a percent of GNP.
France (continued)
Domestic-US long-term 1.0 1.4 2.1
interest rate differential g
Change in exchange rate with 5.5 -6.3 -21.8
dollar h
United Kingdom
Short-term interest rates b 5.9 13.8 14.8
Long-term interest rates b 9.6 13.3 15.7
Inflation e 9.2 17.0 11.4
Real economic growth d 2.8 -1.9 0.6
Government budget deficit e 1.1 4.7 3.5
Change in money stock (M2) f 15.0 18.5 19.0
Domestic-US short-term 0.4 -2.1 1.2
interest rate differential s
Domestic-US long-term 3.0 1.1 1.5
interest rate differentials
Change in exchange rate with NEGL 10.5 -21.1
dollar g
Short-term interest rates b
Long-term interest rates b
Inflation c
Real economic growth d
6.8 17.9 20.6
8.8 17.1 21.6
9.4 19.8 14.1
4.4 0.5 0.6
Government budget deficit e
Change in money stock (M2) f
Domestic-US short-term
interest rate differential g
Domestic-US long-term interest
rate differentialg
Short-term interest rates b
5.5
14.2
15.8
Long-term interest rates b
7.8
13.0
15.4
Inflation c
7.8
9.8
11.1
Real economic growth d
4.6
0.5
1.0
Government budget deficit a
0.9
4.3
2.7
Change in money stock (M2) f
14.5
9.5
15.8
Domestic-US short-term
interest rate differential 8
-1.4
-1.6
2.2
Domestic-US long-term
interest rate differential s
0.8
0.7
1.3
Change in exchange rate with
dollar h
-0.1
-0.8
-0.7
f Percent change in M2 definition of money supply, fourth quarter to
fourth quarter.
g Yearend domestic quotes minus yearend US quotes, for the years
corresponding to the domestic country's low interest years,
percentage points.
h Percent change fourth quarter to fourth quarter.
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The Role of US Rates Aside from the well-established influence of US interest rates on Canadian
financial markets, internal economic conditions and policy decisions in the
other Summit countries generally determine their domestic interest rates.
During the last year, however, US interest rate trends have also been
influential. A number of Summit countries have responded to high US
rates by tightening monetary policies to limit capital outflows and currency
depreciations. As a result, their interest rates are higher:
? In West Germany, higher US interest rates reinforced the upward
movement in West German interest charges by creating an unusually
large West German-US interest rate differential. This differential
stimulated an outflow of capital from West Germany that the Bundes-
bank responded to by tightening monetary policy.
? High US interest rates have also induced policy responses from the
Japanese. Specifically, to limit outflows to US money markets, Tokyo has
tightened controls on international capital flows. This response contribut-
ed to the decline in nominal interest rates already under way because of
weak economic growth and slowing inflation, but has not been sufficient
to prevent high real rates.
? In the United Kingdom, the impact of US interest rates is not as clear-
cut as in Japan and West Germany, but there are indications that US
rates have helped hold UK interest charges up. In particular, UK rates
did not decline in 1981 despite slowing inflation, essentially no economic
growth, a declining budget deficit, and continued increases in the money
supply.
US rates chiefly affected French and Italian rates indirectly, through
forces created within the European Monetary System by the higher West
German rates. This effect has been overshadowed, however, by substantial
upward pressure on interest rates from domestic factors. The size of.
government budget deficits in both countries jumped substantially-in
France from approximate balance to nearly 3 percent of GNP-and stood
well above levels prevailing in low-interest-rate years. In France interest
rates were likely also boosted by a sharp acceleration in inflation, and in
Italy by particularly severe tightening of monetary policy.)
25X1
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Outlook and Interest rates in the Summit countries should decline slowly during the
Implications remainder of 1982. Several factors will contribute to this outcome:
? Any decline in US rates will put some downward pressure on interest
charges abroad.
? Real rates are extremely high, as inflation has dropped but nominal
interest rates have not (figure 2). If the slowdowns in inflation that have
occurred in West Germany, Japan, the United Kingdom, and Italy
continue, expectations of high inflation should gradually diminish and, in
turn, lead to a drop in nominal interest rates. 25X1
? It seems probable that monetary policy in some countries will be loosened
in response to weak real economic conditions and high unemployment
Forces that might inhibit lower interest rates in 1982 include a revival in
real economic activity, which would increase private demand for credit,
and continued or faster-than-expected rises in government demands for
credit. These forces could keep interest rates at or near present high levels.
In turn, the expected recoveries, which are based in part on anticipation of
falling interest charges, would have much slower going, and pressures
would build for loosening monetary or fiscal policy in all of the Summit
countries.
If Summit governments respond by adopting more expansionary fiscal
stances, with no change in monetary policy, then a probable outcome will
be more favorable growth prospects, little change in inflation, but a
continuation of high interest rates. Should the monetary option be chosen,
growth prospects would improve, both nominal and real interest rates
would likely decline, but the seeds would be sown for accelerated inflation
in 1983. Given the already high level of budget deficits and the relatively
tight monetary stances in several Summit countries, we expect most
expansionary shifts to occur in monetary policy.
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Figure 2
Summit Countries: Interest Rates and Inflation
Fourth-quarter changes in GNP deflator (percent)
Average of short- and long-term interest rates (percent)
O Periods of positive real interest rates
0 Periods of negative real interest rates
0 1960 64 68 72 76 80
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