interest-ratesIt’s known that in accordance with Fisher’s equation, $r = i - \pi.$ Imagining an obvious scenario in which nominal rate is essentially zero and inflation exists, we have a negative real interest to work with. Can you think of a way to intuitively explain this to students not very economics-oriented? With positive real interest rate the set up was simple; if you have a unit of capital that costs $100 to buy and a real interest rate of, say $3 per year, then you could simply say that the value of the product that the machine produced is equal to 3 dollars. Any ideas on how to present this concept given negative interest rates?
As a somewhat caricatured example you could suppose you have 100 dollars for which you can buy 100 cheeseburgers, or 2 nice shirts, but you don’t need those right now. So fearing that someone will steal your money or it will be taxed away you buy a one-year (zero-coupon) government bond at zero nominal interest, so it’ll give you 100 dollars back in one year. However, in that year the economy struggled: there was no productivity growth and the FED, in this extreme example, eventually doubled the money supply through its quantitative easing. So at the end of the year you are paid $100 by the government, but you can now only buy 50 cheeseburgers or a single nice shirt. The real effective rate of interest was therefore -50%.
Numbers can of course be adjusted for a more realistic example. I.e. investing the money at 2% nominal interest would have been better than just holding on to the cash even if the return on both “investments” is negative in real terms.
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