Theme 2 & 4: Negative interest rates

In some Euro Zone countries, both the nominal and real interest rate has become negative. Using a numerical example, distinguish between nominal and real interest rates.Explain how negative interest rates might impact on two macroeconomic objectives.

Using a numerical example, distinguish between nominal and real interest rates

• Nominal interest rates are the money rates of interest on savings and loan products.
• The real interest rate = the money rate of interest minus the inflation rate.
• For example, if the nominal yield on a 10 year UK government bond is 0.6% and the 10-year expected inflation rate is 1.6% then the real yield on the bond = -1%.

Explain how negative interest rates might impact on two macroeconomic objectives

Negative policy rates apply at the moment in some countries (e.g. Japan, Sweden, Denmark and Switzerland)

Negative interest rates are designed to get commercial banks lending because they will pay the central bank interest for holding money on deposit with them.

Negative rates may also bring about a reduction in real interest rates – which might in turn stimulate increased business investment and help an economy escape a liquidity trap and return to stronger economic growth

Negative rates are partly designed to cause an outflow of hot money thereby depreciating the exchange rate.

This will help to improve the trade balance (if the Marshall Lerner condition holds) and therefore stimulate aggregate demand and short-term economic growth.