Macroeconomics For Dummies®, uk edition Published by: John Wiley & Sons, Ltd

Negative real interest rates

One of the main tools policy makers have at their disposal to boost the economy is lowering interest rates. (For a detailed look at monetary policy,

see Chapter 10.) But here, briefly, we rearrange the Fisher equation ( ; see the earlier section ‘Connecting inflation to interest rates’) to give:

In other words, the real interest rate (r) is equal to the nominal interest rate (i) minus inflation (π). In order to really boost the economy, policy makers would like to have a negative real interest rate. Among other things this would encourage households to spend now, because the real returns on saving are now negative.

If inflation is positive, achieving a negative real interest rate is easy: just set the nominal interest rate to be less than inflation. But with no inflation (π = 0), having a negative real interest rate is impossible; policy makers can’t choose a nominal interest rate of less than zero – because it would mean putting £100 into your bank account and getting back, say, £95. People would prefer to keep cash under their mattress!


Rising to Extremes: Hyperinflation


Hyperinflation refers to extremely high inflation. No agreed precise definition exists of what constitutes hyperinflation, but people in an economy experiencing it typically notice that the prices of things rise on a daily basis. Something that costs £1 today may cost £1.20 tomorrow, £3 by the end of the week and £90 by the end of the month!

In this section you see how a government suffering from fiscal problems can fund itself in the short term by running the money printing presses and how

this behaviour leads to inflation and then hyperinflation. We describe how this behaviour worsens the government’s fiscal problems and leads to a vicious cycle whereby more and more money needs to be printed. In the end, the only way to stop hyperinflation is to fix the underlying fiscal problems that led to the need for printing money in the first place!