The Tax Effect, and the Recent Behaviors of the After-Tax Real Rate: Is it Too High?

Recent years have witnessed very high and volatile interest rates. This has stirred a debate among analysts as to whether observed interest rates are high by historical standards. Some analysts, focusing on the before-tax real rate, argue that if the observed nominal interest rate is corrected for the effect of expected (or actual) inflation, the ex ante (or ex post) real rate has been very high in recent years. Other analysts, however, note that it is also important to consider the effect of taxes on the behaviour of the nominal interest rate. Since real spending decisions in the economy are based on the after-tax real rate, it is more appropriate to focus on the behaviour of this latter real rate. Proponents of this view argue that the after-tax real interest rate observed since 1980 does not appear to be too high.