Why Are Inflation and Real Interest Rates So Low? A Mechanism of Low and Floating Real Interest and Inflation Rates

Harashima, Taiji (2018): Why Are Inflation and Real Interest Rates So Low? A Mechanism of Low and Floating Real Interest and Inflation Rates.

Abstract

Real interest and inflation rates have been very low in many industrialized countries since the Great Recession. In this paper, a mechanism of low and floating real interest and inflation rates is examined based on the concept a “Nash equilibrium of a Pareto inefficient path” and the law of motion for trend inflation. I show that, because the link between the marginal product of capital and the real interest rate is severed on this path, the real interest rate loses its anchor and therefore floats. In addition, the inflation rate floats together with the real interest rate. There are, however, upper and lower bounds of the floating rates. It is also likely that the real interest rate floats below the marginal product of capital on this path and the inflation rate floats below the target rate of inflation.

• Item Type: MPRA Paper
• Language: English
• Keywords: Real interest rate; Inflation; Deflation; Marginal product of capital; Pareto inefficiency; Monetary policy; Fiscal policy; Bank behavior
• Subjects: E - Macroeconomics and Monetary Economics > E2 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy > E21 - Consumption ; Saving ; Wealth; E - Macroeconomics and Monetary Economics > E2 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy > E22 - Investment ; Capital ; Intangible Capital ; Capacity; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E31 - Price Level ; Inflation ; Deflation; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations ; Cycles; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E43 - Interest Rates: Determination, Term Structure, and Effects; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E62 - Fiscal Policy; G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks ; Depository Institutions ; Micro Finance Institutions ; Mortgages

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