RE: Re: P.S.

["Devine, James" <jdevine@xxxxxxx>]

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