30

The CPI stands for a Consumer Price Index. As in the price of things that are consumed (at a particular moment in time). Real estate prices are not the price of something consumed because they contain the value of current housing consumption but also the capitalized value of future housing consumption. As such, including house prices would make the CPI a ...


14

You are assuming that the supply of deposits is zero when the price (the rate) is zero but it definitely is not. There are several reasons for this. While you can withdraw cash from the bank it is unwieldy, costly, and unsafe to have large amounts of cash lying around. Therefore, if there were no other alternatives, heavy spenders would still want some ...


14

The low interest rate will be in a different currency. If your domestic currency falls in value, the value of the mortgage in terms of the domestic currency goes up. Entities borrowing in a foreign currency and then running into difficulties is a standard features of financial crises over history.


14

What does stop me from taking a loan from a bank in a rich EU-country to build or buy a house in a poor country like Russia, while having EU-level interest rates below 3% instead of the Russian 15%? Other answers have already mentioned the currency risk you would have. Further limitation is that most European banks won't give you a loan at 3% interest for ...


11

Actually they're saying that, when cash is available, people need not to deposit their money into the bank, and hence is "guaranteed" (not taking into account risks associated with holding on to cash, like fire or getting stolen) a 0% interest rate. Having cash, therefore, means that if the deposit rate goes into the negative territory (you're charged to ...


10

There was only one reason to ever think that nominal interest rates couldn't go negative, which is that the nominal return on both forms of base money (electronic reserves, and paper currency) had a floor of zero -- and investors wouldn't accept a below-zero nominal return when they could get a higher one by holding base money. But for electronic reserves, ...


10

Its important to keep in mind that the exchange rate is a "price for currency" and just like any other price it is determined by supply and demand. The main question now is what determines supply and demand for currency? There are two main models that tell us how exchange rates behave based on the two main forces driving demand (and supply) for ...


9

Assuming your home is safe, would you keep your money in a bank that only gave 96% of it back? (-4% interest rate) What if your home has mice which eat exactly 10% of your money? Would you then keep your money in the bank that only returns 96%? And finally, what if every bill has a 10% chance of being eaten? This means that in expected value you lose 10% ...


9

It's true that in response to an oil shock, the Taylor rule could recommend increasing the interest rate to reduce inflation. In practice it would mean that as interest increases, consumption falls. This could be from less credit financed spending, or because the opportunity cost of holding money has increased, therefore people invest more in illiquid assets ...


9

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 ...


8

The Fed controls the nominal money supply as they are the only ones who can add or remove money from the economy by printing it. Real money supply is only affected by increases or decreases in inflation and is fixed assuming inflation is 0. In the IS-LM model which is what I assume you are referring to it is assumed that inflation is fixed or that the fed ...


8

A private person will almost never have an access to borrowing at risk free rate. However, governments such as Germany or Switzerland can borrow at essentially for all practical purposes at risk free rate by issuing government bonds. As a private person you might get access to risk free loan if you are rich enough to be able to negotiate the rate with bank ...


8

There are several reasons why it makes still sense. Nominal negative return does not mean that real return is negative. There is a difference between nominal interest rates and real interest rates which can be expressed by the Fisher formula: $$ i \approx r + \pi$$ Where, $i$ is the nominal interest rate, $r$ is the real interest rate and $\pi$ is ...


7

You're right to ask; the sentence you bolded is unclear in its wording. The effect of randomly invalidating 1/10th of the currency outstanding in one year is that in expectation, cash would have an interest rate of -10%. So when Mankiw says the policy "might enable central banks to set negative interest rates provided the rate was less than 10%", he means "...


7

You anticipate the answer when you ask: This question can be easily answered if there were any way in which new money can leave the central bank without being paid back. Are there such transactions I don't know about? Indeed, there is always a way that money leaves the central bank without being paid back: the central bank does something with its net ...


7

There is some concern about the interest rates (currently at -0.5%) fueling a housing bubble in Sweden. This article at Fidelity states: In a bid to track the ECB, Sweden has cut its interest rate below zero, a radical move that involves charging banks to hold some types of deposits with the aim of encouraging them to lend. Similar trends have ...


7

It makes little sense to me either, but here are some possible reasons for buying a bond with negative interest rates rather than depositing the same amount in a bank: The deposit-taking bank may go bankrupt during the lifetime of the bond and your deposit would be too large to be guaranteed, with the cost of default insurance being higher than the the ...


7

An interest rate is the percentage that is paid for borrowing money, and that one gets for lending. If it is negative that means you have to pay so that someone takes your money for a while. So how could that even work, why should anyone lend money under such conditions? Normal savers would just keep their money with them, even if that bears the risk that it ...


7

What would happen in the event of a "Leave" vote in the referendum? Well, the pound would quickly fall in value against its major trading partners - and some falls have already happened as the "Leave" vote appears to increase in probability. That makes imports more expensive, which is directly inflationary. Which pushes the Bank of England (the UK's Central ...


6

Suppose the face value of a bond is $M$ and its interest rate is $\tau$. This means it will pay $\tau \cdot M$ interest every year (other periods are also possible) and at the end of its run (its maturity) it will also repay the face value $M$. Government bonds are usually sold in auctions. Whatever ends up being the market price is considered to be the ...


6

Handing out the principal amount of debt gradually, in increments, is standard practice in investment loans extended by a bank to a corporation. The rationale is clear : the corporation wants to make an investment, say a new factory. The whole plan is laid out and the cash flows of the pre-operational, construction period are also detailed, based on ...


6

Recently I read an interesting paper on this subject from the Bank for International Settlements: Juselius, Mikael and Takats, Elod, Can Demography Affect Inflation and Monetary Policy? (February 2015). BIS Working Paper No. 485. Available at SSRN: http://ssrn.com/abstract=2562443 The abstract: Several countries are concurrently experiencing ...


6

To answer the first part, it's an "annualised" interest rate convention - like all other quoted interest rates. For example, if a one-month money market rates are unchanged at 4%, you would receive approximately 4% in interest after a year, or roughly 1/3% a month. (Note that those numbers are ignoring compounding, further details below.) As for the ...


6

There is a fair amount of ambiguity to this question. The first question is: what is the yield curve? A fixed income investor may refer to the yields across all maturities as the yield curve, while economists pick the difference in yields between two arbitrary maturities as the yield curve. Which two? Typical choices are the spread between the 2-year and 10-...


6

Does Adam Smith ... support a Central Bank/Federal Reserve? Adam Smith was firmly in favor of central banking (although not necessarily in the same way as understood today). In Chapter 3 Book 4 of The Wealth of Nations he writes: “In order to remedy the inconvenience to which this disadvantageous exchange must have subjected their merchants, such small ...


6

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 ...


5

An interest rate is the return that a lender earns on money lent to someone else. If the interest rate is higher then it makes lending money more attractive because the return is higher. In particular, if the interest rate in, say, Russia increases relative to that in the USA then American lenders will switch from lending their money in America to lending ...


5

This is the two-period budget constraint: C1 + C2/(1+r) = Y1 + Y2/(1+r) Derivation is straightforward. On the LHS, you have the present value of consumption (considered during period 1), and on the RHS you have the present value of income. Intuitively, think about 1/(1+r) on the LHS as the price ratio between Good 1 and Good 2. Now you can solve the u-...


5

French economist Jean-Baptiste Michau has published in 2018 a relatively simple model of secular stagnation: To investigate secular stagnation, I add two features to a standard Ramsey model with money: (i) Households have a preference for wealth; (ii) Wages are downward rigid. In this framework, there exists a frictionless neoclassical steady state ...


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