Deterioration in the real interest rate of an economy can lead to an economic downturn. In essence, if inflation rates exceed the interest rates on lending, the profitability of commercial banks is eroded and lending to businesses and individuals dries up. As a result, the production and consumption of goods and services by these would-be borrowers falters.
- Most economies at some point experience negative real interest rates. During the 2014-2015 period, Argentina, Japan, Mexico, Ukraine, the United Kingdom, and Venezuela, among other economies, experienced negative real interest rates, meaning that the inflation rate exceeded the lending interest rate.
- Last July, US real interest rates on the 10-year Treasury bills fell below zero for the first time since 2012. For the economy more broadly, as is the case now, the United States experienced a period of relatively low real interest rates during the 1970s, with a single one-year period - 1975 - falling into negative territory (-1.28 percent).
To complicate matters, the reasons for and repercussions to an economy of low or negative real interest rate depends on a myriad of other factors, including an economy's size and demographic profile, capacity and maturity of its banking system and related financial institutions, demand for safe assets, and other factors. The duration of the low or negative interest rates also affects policy decisions to guard against other economic consequences.
- A low real interest rate can signal that a country is a low credit risk and has a relatively stable economy, helping to boost economic growth to prevent recession or aid economic recovery. Maintained at a low rate over several years, however, with no return to stronger economic growth will probably trigger other policy responses to address the consequences of low rates throughout an economy including on the health of the banking sector and wealth distribution between economic classes.
- Negative interest rates, while less optimal, pose a greater threat when nominal lending interest rates are also low, as observed at various points in history in Japan, the United Kingdom, and a handful of other advanced countries.
- Even more economically disruptive are scenarios in which the negative real interest rate is coupled with high interest rates on lending, such as in Argentina, Brazil, Ukraine, and Venezuela. This scenario is more common among developing economies in which banks dominate the financial system.