But when prices are falling, the real interest rate exceeds the nominal rate.

The effective interest rate, effective annual interest rate, annual equivalent rate (AER) or simply effective rate is the interest rate on a loan or financial product restated from the nominal interest rate as an interest rate with annual compound interest payable in arrears.

Domestic deflation means that the real interest rate on Japanese bonds is higher than the nominal rate.

A ten year Treasury has a nominal interest rate of less than 2 .

A normal US economy has a short term nominal interest rate of 4 .

The second adverse effect of deflation is to raise the real interest rate, that is, the difference between the nominal interest rate and the rate of inflation.

And, due to rising consumer prices, the nominal interest rate will continue to rise.

When prices are rising, the real interest rate is less than the nominal rate since the borrower repays with dollars that are worth less.

Moreover, even if prices on average exhibit some downward flexibility, deflation necessarily increases the real rate of interest, given that nominal interest rates cannot fall below zero.

Fear over the growth effects of the European Central Bank s 2006 rate increases is based on confusion between real and nominal interest rates.

A key parameter for determining the long run sustainability of public debt is the gap between interest rates and the nominal GDP growth rate.

And, because people trade bonds for commodities, cash, and stocks, the prices of government debt are the rate of inflation, the nominal interest rate, and the level of the stock market.

Past experience implies that the real rate will rise to at least 2 , taking the total nominal interest rate to more than 4 , even if expected inflation remains at just 2 .

Multipliers are higher perhaps around 1.7 when the nominal interest rate is at its lower bound of zero, as it was during 2009... (and is today).

Its nominal interest rates will rise as bondholders fear inflation.

The current small difference between the real interest rate on such bonds (2.1 for 30 year bonds) and the nominal interest rate on conventional 30 year Treasury bonds (now 4.6 ) implies that the market expects only about 2.5 inflation over the next three decades.

But real interest rates did not fall enough, because nominal interest rates cannot go below zero.

The degree of financial repression in a country can be estimated by calculating the gap between the average nominal GDP growth rate and the average long term interest rate, with a larger gap indicating more severe repression.

A prolonged and sustained central bank policy of keeping short term Treasury nominal interest rates low is essential to keeping the many interest rate sensitive components of aggregate demand from falling even further below potential aggregate supply.

A higher rate of expected inflation would also cause the total nominal rate to be greater than 5 .

Banks issue securities with attractive nominal interest rates but unknown repayment probability.

History shows that rising inflation is eventually followed by higher nominal interest rates.

The zero lower bound arises because nominal interest rates cannot fall below zero.

America s Interest Rate Puzzle

China s Interest Rate Challenge

Since WWII, the US unemployment rate has averaged 8 when the short term nominal T bill rate is 2 or lower.

Stated differently, now that Greece has achieved a zero primary budget deficit, its debt burden will decline if its nominal growth rate exceeds the average interest that it pays on its government debt.

The Real Interest Rate Risk

To define an interest rate fully, allowing comparisons with other interest rates, both the interest rate and the compounding frequency must be disclosed.

Food provided in government hospitals is either free of charge or at a very nominal rate.

While nominal GDP generally rises over long periods of time at the same rate as the money stock, with interest rates very low and declining, households and institutions were willing to hold more money relative to total nominal GDP after 2008. So, while M2 grew by more than 6 , nominal GDP grew by just 3.5 and the GDP price index rose by only 1.7 .

Although it is difficult to anticipate how high long term interest rates will eventually rise, the large budget deficit and the rising level of the national debt suggest that the real rate will be higher than 2 . A higher rate of expected inflation would also cause the total nominal rate to be greater than 5 .

In 2012, the growth rate of M2 was about 14 , relatively low by historical standards, but still significantly higher than the nominal GDP growth rate.

But interest rate convergence caused economic divergence.

A rising nominal and real exchange rate can propel structural change a weak currency policy is a trap.

Moreover, interest rates cannot become negative in nominal terms, and rising public debt may increasingly disable fiscal policy.

According to the followers of Knut Wicksell, the central bank must keep the market rate of interest near the natural rate of interest.

This is exacerbated by the fact that borrowers can deduct only nominal interest payments when calculating their taxable income.

Once nominal interest rates cannot be lowered further, central banks use other tools to determine the monetary policy stance.

But financial decentralization extends beyond interest rate liberalization.

Because the inflation rate is also about 2 , this implies a negative real interest rate, which is confirmed by the interest rate of 0.6 on ten year Treasury Inflation Protected Securities (TIPS), which adjust interest and principal payments for inflation.

Indeed, despite domestic resistance, the PBOC must raise nominal interest rates so that they are in line with structural inflation.

At present, the interest rate is less than 0.5 .

Emerging market interest rate spreads now are abnormally low.

Italy, however, chose to squander that interest rate advantage.