Question

People complained about ‘negative real interest rates’ in the early 1990s, and again since 2009. Can real interest rates be negative? How can that be so?

Answer 1

Negative interest rates arise when interest is paid to borrowers rather than interest owed to lenders. During a deep economic recession, this rare scenario would most likely occur when monetary policy and market forces have already driven interest rates to their nominal zero limit.

Although real interest rates can be negative if inflation exceeds the nominal interest rate, the nominal interest rate was theoretically bounded by nil. Negative interest rates are mostly the product of a desperate and vital attempt by financial means to improve economic growth. The zero-bound refers to the lowest level below which interest rates will fall, and logic dictates that that level will be zero.

Financial institutions are expected to pay interest on parking excess assets with the central bank, under a negative rate strategy. That is, any extra cash that goes beyond what the regulators claim banks must hold on hand. Thus, central banks penalize financial institutions for holding on to cash in the hope of enticing companies and consumers to raise lending.

Nonetheless, negative rates say they help weaken a country's currency by making it less attractive than other currencies. A weaker currency gives a competitive advantage to a country's export, and boosts inflation by boosting import costs. That is one of Trump's reasons to want the dollar to have negative levels. Negative central bank rates even reduce borrowing costs on a variety of instruments, which means companies and households are getting even cheaper loans.There are also limitations on how far central banks can drive rates into negative territory-by opting on store real banknotes instead, depositors can avoid being paid negative rates on their bank deposits.