Jim writes: >> real rate of interest = nominal rate of interest + rate of deflation.<<
Sabri writes: >First of all, this is an approximate relationship which holds true for small rates only so assume that rates are small.< right. But it's harder to type the correct formula. The approximation is "good enough for pen-l work." >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.< my premise is that nominal interest rates are very low in Japan, as they are. >... So your conclusion that in a deflationary economy negative real interest rates are impossible does not follow from the above relationship.< did I say "impossible"? If I did, sorry! >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.< are negative real interest rates prevailing in Japan at this point? Of course, we could presume a Krugman-type policy. Suppose that the nominal interest rate is 1%. The deflation rate is 5%, so that the _ex post_ real interest rate is 6% (approximately). If the _expected_ deflation rate equals 5% also, then the _ex ante_ or expected real rate is also 6% (or so). Now, PK becomes the head of the Bank of Japan and imposes a policy of inflation-targetting, with the target inflation rate being 3%. Supposing that financial speculators and their ilk ignore the large numbers of Japanese bankers who are pissed at having a gringo running the show and are aiming their daggers at Paul, so that the Bank of Japan's policy is "credible." Thus, they begin to expect 3% inflation. In that case, the real expected or _ex ante_ interest rate would be -2% (mas o menos). However, until the policy actually began to achieve its goals of causing a inflation rate above about -1% per year, the realized or _ex post_ interest rate would continue to be positive. JD
