The real interest rate has a lower bound at approximately zero because The premise is false....

The real interest rate has a lower bound at approximately zero because

The premise is false. Real interest rates do not have a lower bound of approximately zero
No one would lend money if the real rate of return was expected to be negative
No one would lend money if the nominal rate of return was expected to be negative
Nominal interest rates adjust to inflation expectations

Expert Solution

Real interest rate is defined as the nominal interest rate adjusted for inflation in the economy. For instance, if the nominal interest rate in a particular economy is r and the rate of inflation is i, then the real interest rate is the difference between the two.

That is, real interest rate = r-i

Real interest can be positive, zero or negative depending on the relative magnitudes of the nominal interest rate and the rate of inflation. If the former is higher in magnitude than the latter, then real interest rate is positive. However, if the rate of inflation exceeds the nominal rate of interest, then the real interest rate is negative. In the rare case when r=i, real interest rate is 0.

So, there is no lower bound for real interest rate. It all depends on the relative magnitudes of nominal interest rate and the inflation rate.

So the correct option is (a).

Rahul Sunny answered 2 years ago

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