How negative real interest rate can occur?implications of negative real interest rate?
Answer:
Inflation is greater than nominal interest rates.
Among other things, this transfers wealth from lenders to borrowers.
A negative real interest rate occurs when the rate of inflation is higher than the rate at which loans gain interest at (the nominal interest rate). Therefore, the interest a borrower pays is not actually going to be worth what their paying.
Because those giving loans can't actually make money off the loan they will then stop issuing loans, at least until the nominal rate gets above the rate of inflation. This seriously imbalances the credit market.
Let's say I loan you some money at 6 percent interest.
If inflation is 2%, then my real return is only 4%. This is a 'real' return because the amount of stuff I can buy with the money has been reduced by inflation.
Now, what if inflation was 7%? Then the real return is -1%, and I have actually lost money loaning money to you. Needless to say I am unhappy. However, I may not have a choice, because if I left my money sitting on my mattress it would also shrink in value. I could invest it myself, but that is really not my business to do that. However, to the extent I can, I would get rid of cash and maybe buy longer term bonds with a higher return. I would likely buy a politician who will hit the brakes at the FED, but that is another matter.
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