The recent decline in interest rates has been encouraging news to borrowers, but economists warn that new pressures will keep rates from settling to levels that might have been expected a few years ago.
Historically, real rates of interest have run about 3 percent above the inflation rate, but although the inflation rate has fallen sharply in the past two years, interest rates have remained high.
Economists say the factors putting pressure under interest rates include uncertainty caused by the large federal budget deficits, deregulation of the financial industry, the anti-inflationary monetary policy of the Federal Reserve and lingering fears that inflation will revive -- although the cooling of those inflation fears has been a major reason for the recent decline in rates.
"Part of the reason why real rates are so high is the budget deficits, the fact that people still focus on these numbers and say somewhere along the line financing for the public debt and financing for all the other things we need are going to get tighter," said Elizabeth A. Ginste, assistant vice president at Dean Witter Reynolds Inc.
"That's the kind of expectation in the marketplace," Ginste said, "that the deficit isn't getting any better, that it's going to be a larger problem than it is today."
Moreover, said Bernard Markstein III, a senior financial economist for Chase Econometrics, as long as there is some uncertainty in their investment, investors want some security for taking that risk.
In the last month, rates for three-month certificates of deposit have declined by about 1.5 percentage points, and some longer-term bonds have fallen by at least one percentage point.
Contributing to the decline has been the recognition by the financial markets that inflation probably will remain in the 4 percent to 6 percent range and not return to double-digit levels, economists said.
However, some experts such as Robert Ortner, chief economist for the Commerce Department, said that many investors still are worried about inflation, and that is a major reason for high real interest rates. He added that the perception of the problem of large budget deficits also is a factor.
"There is still a lot of inflation psychology out there," Ortner said. Interest rates "may never go back to what we came to regard as normal real interest rates of 2 to 3 percent," but that was when interest rates were prevented by the government from rising too high, Ortner said.
Several years ago the government began phasing out regulations that limited the amount of interest banks could pay for deposits. For example, five years ago the maximum interest rate allowed on three-month certificates of deposit was 5.5 percent.
With the removal of most such ceilings, banks and other financial institutions have been allowed to offer rates as high as they want. One result has been to increase the banks' cost of raising money, which has been passed along to borrowers in the form of higher interest rates.
Although elimination of the regulation has led to higher interest rates, Markstein of Chase Econometrics said it may also tend to reduce the severity of economic declines.
In the past, banks were forced to halt lending as rates climbed because they were not allowed to pay dividends high enough to attract deposits.
However, now economic activity can continue when the costs of doing business increase, but borrowing just becomes more costly, economists said.
Another reason given by economists for high interest rates has been the anti-inflationary policies of the Federal Reserve since the early 1980s.
The Fed has attempted to keep the growth of money from increasing too rapidly, fueling demand and causing higher prices.
But although the Fed's policies have kept inflation relatively low, they have kept interest rates high by making the supply of money and credit tighter. The Fed only recently eased credit conditions, after which interest rates started to edge downward.
Many major forecasters have predicted that by the end of the decade, long-term rates, such as 20-year Treasury bonds, will not decline much below 9 percent or 9.5 percent, about 2 percentage points below what they are now.
Short-term rates, such as the federal funds rate, probably will go no lower than 8.5 percent to 9 percent, those economists said, about one-half to one percentage point below what they are now.
The outlook for interest rates is a central part of the debate over prospective budget deficits. The interest on the national debt is one of the fastest growing segments of the federal budget; according to the Congressional Budget Office, the government's net interest expense will grow from about $22 billion in 1985 to $103 billion in 1989.
A major reason for the discrepancy in budget deficit forecasts between the administration and others such as the CBO has been in projections on the interest expense, based on assumptions of interest rate levels.
The CBO in its midsession budget review last August estimated that the three-month Treasury bill rate would average about 8.9 percent from 1986 to 1989, when the deficit was expected to grow from $195 billion to $263 billion.
However, the administration in its August review forecast that if no other policy action were taken, the deficit would decline to $161.7 billion.
The discrepancy is largely due to the much lower interest rate estimates of the administration. For example, the administration forecast the three-month Treasury bill rate would be about 5.0 percent by 1989