Discussing interest rate structure in class, we defined the concept of “Real” In
ID: 1116045 • Letter: D
Question
Discussing interest rate structure in class, we defined the concept of “Real” Interest Rate as developed by economist Irving Fisher. You will recall that Fisher defined the Real rate as equaling the nominal rate minus anticipated inflation. Examining actual interest rate structure in the U.S. currently, we found that many Real rates, including ALL Treasury Bond rates, were negative. Based in the Fisher model, this is an outcome we would never expect to see. It means that participants in the T-Bond market are not even recovering the value of their investments that is lost to price inflation: They are actually paying the government to borrow their money! Before 2008, this market situation had never occurred for a sustained period of time. Participants in the T-Bond market are generally knowledgeable and expert. The Question of the week is this: Why is it that under current market conditions market participants are willing to accept negative real returns on their loans to the Treasury?
Explanation / Answer
Real interest rate also consider the actual inflation rate existing in an economy , if they are negative inflation is high which means investors are losing money. This was captured in the fisher effect when there is a fall in demand for securities investor may even accept to lend at negative interest rates. Mostly investors always had the option of fail on trade so such securities had no reason to be borrowed for negative interest rate but exceptions were always there.Oveer the years there came a better way of trading for negative interest as there was no cost on failure of repayment.