Negative Real Interest Rates
The real interest rate solved from the Fisher equation is
If there is a negative real interest rate, it means that the inflation rate is greater than the nominal interest rate. If the Federal funds rate is 2% and the inflation rate is 10%, then the borrower would gain 7.27% of every dollar borrowed per year.
Negative real interest rates are an important factor in government fiscal policy. Since 2010, the U.S. Treasury has been obtaining negative real interest rates on government debt, meaning the inflation rate is greater than the interest rate paid on the debt. Such low rates, outpaced by the inflation rate, occur when the market believes that there are no alternatives with sufficiently low risk, or when popular institutional investments such as insurance companies, pensions, or bond, money market, and balanced mutual funds are required or choose to invest sufficiently large sums in Treasury securities to hedge against risk. Lawrence Summers, Matthew Yglesias and other economists state that at such low rates, government debt borrowing saves taxpayer money, and improves creditworthiness. In the late 1940s through the early 1970s, the US and UK both reduced their debt burden by about 30% to 40% of GDP per decade by taking advantage of negative real interest rates, but there is no guarantee that government debt rates will continue to stay so low. Between 1946 and 1974, the US debt-to-GDP ratio fell from 121% to 32% even though there were surpluses in only eight of those years which were much smaller than the deficits.
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Famous quotes containing the words negative, real, interest and/or rates:
“The negative cautions of science are never popular. If the experimentalist would not commit himself, the social philosopher, the preacher, and the pedagogue tried the harder to give a short- cut answer.”
—Margaret Mead (1901–1978)
“I had the idea that there were two worlds. There was a real world as I called it, a world of wars and boxing clubs and children’s homes on back streets, and this real world was a world where orphans burned orphans.... I liked the other world in which almost everyone lived. The imaginary world.”
—Norman Mailer (b. 1923)
“Mr. Bok is giving the bird sanctuary as a tract of land at this place. He is dedicating it as a bird sanctuary and putting up these bells to interest the birds in music.”
—Calvin Coolidge (1872–1933)
“Good government cannot be found on the bargain-counter. We have seen samples of bargain-counter government in the past when low tax rates were secured by increasing the bonded debt for current expenses or refusing to keep our institutions up to the standard in repairs, extensions, equipment, and accommodations. I refuse, and the Republican Party refuses, to endorse that method of sham and shoddy economy.”
—Calvin Coolidge (1872–1933)