9
$\begingroup$

I am familiar with the real interest rates equation which states that real interest rate = nominal interest rate - expected inflation rate.

What I am failing to fully grasp, however, is why would lenders be willing to provide a supply of loans for a negative real return?

Obviously it is the market that leads them there, but what is it that drives the market to that point?

$\endgroup$
1
9
$\begingroup$

If there is inflation, what is your alternative? If you do not lend, your money loses even more of its value.

A numerical example:
If inflation is 5% and you can lend at 2% nominal interest rate, you can make the loan and lose 3% of your money's purchasing power OR you can not make the loan and lose 5% of your money's purchasing power.
Poor choices, but one is better than the other.

$\endgroup$
5
  • 2
    $\begingroup$ I understand that. What my question is really focused on are the causes of the real interest rate being negative (-3% in your case) instead of being say 1% or 2%. What are the market forces pushing it down there & why do they occur? $\endgroup$
    – ThomasJ
    Sep 27 at 10:47
  • 2
    $\begingroup$ @ThomasJ Your question specifically asks "why would lenders be willing to provide a supply of loans for a negative real return". This is the supply side of the question, which I explained. The demand side is less mysterious, getting loans at negative real rates does not seems to be a bad deal. So what exactly are you asking about? Why is there so much available financial capital? Why aren't there more/better investment opportunities? IMO these questions are case specific and not about the general mechanism. $\endgroup$
    – Giskard
    Sep 27 at 11:06
  • $\begingroup$ @ThomasJ These are still interesting questions, but they do not seem to have anything to do with the equilibrium rate going under zero. $\endgroup$
    – Giskard
    Sep 27 at 11:10
  • 1
    $\begingroup$ 10 months ago in an answer to a similar question I wrote "a ton of steel bought today will still be a ton of steel in a month, but the \$750 that buys a ton of steel today won't buy a ton of steel next month". And, yup, it actually was \$750 in those long-forgotten days. $\endgroup$
    – hobbs
    Sep 28 at 2:59
  • $\begingroup$ @hobbs and the steel has a higher carrying cost than money; if you need to store $750,000,000 of metal you have more of a problem. Or a market corner opportunity. cnbc.com/2014/06/03/… $\endgroup$
    – pjc50
    Oct 5 at 8:03
6
$\begingroup$

The same reason that oversupply leads to falling prices in any other market. There is a huge amount of money out there, and a lack of good returns with adequate levels of safety, so money is cheap.

The reason this leads to negative rates is that money, like other goods, has a carrying cost. Keeping physical cash requires heavily secured real estate and is a pain to ship around.

When you reach the end of the accounting day with a spare billion that needs to be somewhere, the easiest thing to do is hand it to the Federal Reserve to look after, even if that means paying them a small amount for the privilege. This is called the "overnight window".

$\endgroup$
1
  • $\begingroup$ As of October 2021 the Fed has not gone negative ever in its history for the nominal short term interest rate on reserves parked at the Fed. There has been no payment of interest to the Fed for parking reserves there. So the "payment" to the Fed , if you can call it a payment, is only the loss due to inflation because inflation at the moment is higher than the approximately 10 bp annual rate that can be earned. $\endgroup$
    – H2ONaCl
    Oct 5 at 3:40

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.