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To assess the implications of today's relatively high interest rates, this memorandum reviews the experience of two decades in different sectors of the U.S. economy. Though interest-rate changes can produce many effects--involving saving, investment, exports, and other developments--the Congressional Budget Office has focused in this study on only one: the effects on investment spending in different sectors. One can develop simple rules for predicting the sectoral spending changes that can result from a given change in interest rates. The results of CBO's analysis (shown in Table 1 in the text) must be regarded as highly uncertain, but they suggest that housing is most sensitive to interest rates, followed by nonresidential structures, producers' equipment, and consumer automobiles in that order.

Literature reviewed for the paper suggests that business investment is influenced most strongly by real after-tax interest rates, while consumer investment is affected by all interest-rate changes, whether real or purely nominal. In all cases, however, the effects are indirect; the direct effects of rates are reflected in a measure known as the "rental price" of capital. This measure takes account of all factors affecting the cost of investment. Such factors include tax policy, relative asset prices, and physical depreciation, as well as interest rates themselves.

Because certain of these other provisions cushion the impacts of high interest rates, the current rental prices for certain sectors stand at moderate or even low levels by historical standards, as Figure 1 in the text shows. In particular, the rental price for producers' durable equipment is low by recent historical standards, and that for consumer automobiles is only slightly above its average levels of the 1960s and 1970s. By contrast, quite high rental prices now characterize the housing, nonresidential structures, residential structures, and state and local construction sectors.

A graphic presentation in Figures 2 through 4 separates changes in rental-price measures into those parts caused directly by changes in interest rates, tax policy, and other factors. (There may be interactions among these factors, if, for example, a tax cut helps raise interest rates; but CBO has disregarded these indirect effects in this analysis.) The CBO analysis shows that, in recent years, tax policy and relative prices have overcome the effects of rising interest rates, and these factors have steadily reduced the rental price for producers' equipment. The price for all types of structures, by contrast, has followed the upward course of interest rates.

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