Jim writes: > real rate of interest = nominal rate of interest + rate of deflation.
Jim, First of all, this is an approximate relationship which holds true for small rates only so assume that rates are small. Now, if the absolute value of nominal rate of interest is larger than rate of deflation and nominal rate of interest is negative then even in a deflationary economy real rate of interest can be negative. Like 1 basis point of rate of deflation and -2 basis points of nominal rate of interest result in -1 basis point of real rate of interest. So your conclusion that in a deflationary economy negative real interest rates are impossible does not follow from the above relationship. If in a deflationary economy negative real interest rates are impossible, then there must be another explanation which rejects the possibility of the example I constructed above. Sabri
