interest rate

freeze4real

can nominal interest rate be negative ?

nominal interest rate are interest rate thats not adjusted for inflation.

I've read that nominal interest rate is possible when in recession.

I think its possible.


whats your take on this ?

irish_goat

I remember doing that assignment.

Nominal interest rates should in theory never be zero because people would just hold onto their money instead of buying bonds.

Having said that, if there are costs to holding money (we're talking about large amounts here) then sometimes there can be negative nominal rates. http://research.stlouisfed.org/publications/mt/19990101/cover.pdf

In terms of recessions, if a lot countries began devaluing their currency it may be worth while to switch to a safe currency e.g. Swiss Francs, in which case, negative interest rates may be offered but they would still prove to be a safer investment than the original currency.

freeze4real

hahaha So do I lol,

I knew the answer but my explanation lacked depth.

I knew negative nominal interest rates occurs but rarely, that's according to Wikipedia.

andrew

Be sure that you don't get confused between nominal interest rates and real interest rates.

A nominal interest rate is one which, say, a bank offers somebody. The real interest rate is the nominal interest rate adjusted for inflation and other factors.

If the nominal rate is 1% and inflation is running at 2%, then the real interest rate -1%; it's negative. So the real interest rate can be negative; a recent German bond issue had a negative real interest rate. The real interest rate on cash, then, is negative when inflation is positive, because the nominal interest rate on cash is 0.

But for the nominal interest rate to be negative, someone would have to be offering a negative interest rate. If it was -1% on deposits, say, then it means that the bank is effectively charging you in order to store your money, while at the same time profiting by lending out that same money. Given depositors can pick from a variety of banks, it'd be an exceptional event for a bank to charge a negative interest rate. Why would people deposit money into an account which they know will lose more money than any other account with a non-negative interest rate?

So while a negative nominal rate is possible, i can't think of any circumstance in which a commercial bank would charge such a rate.

The central bank could be a slightly different matter. If the interest rate is 0 central bank wanted to create a monetary stimulus, then conceivably they have two options. They can engage in quantitative easing, which drives the real rate below zero. Or, perhaps they could set the central bank rate to a negative value. This would cause commercial banks to have no reserves at the central bank, leaving them with no other option but to lend out said money if they want to make a return on said money. Such a policy would be pretty weird though, and there might be some stuff i'm missing about the actual practicality of a central bank having a negative nominal rate.

freeze4real

Andrew spot on.

Irish goat do you not mean that people would hold bonds instead of money in this scenario.

what does zero real interest rate imply ?

irish_goat

freeze4real wrote: »

Andrew spot on.

Irish goat do you not mean that people would hold bonds instead of money in this scenario.

No, the nominal interest rate is the rate offered before you adjust for inflation. If the nominal rate on the bond is negative then it would make more sense to just keep your money under your mattress, unless, as my link says above, there are potential costs/dangers keeping the money yourself.