As a result, the interest rate for 12 month fixed deposits has reached 3.9 .

When the economic recovery begins to accelerate, commercial banks will want to use the large volume of reserves that the Fed has created to make loans to businesses and consumers.

So, if the PBOC sets the interest rate on one year deposits at 3 , commercial banks can offer depositors a rate as high as 3.3 .

China s Interest Rate Challenge

The Real Interest Rate Risk

And, in the United States, where inflation exceeds 2 , the Federal Reserve s benchmark federal funds rate remains at an historic low of 0 0.25 .

Under the current system, the fixed differentials between interest rates on deposits and those on loans translate into monopolistic profits for commercial banks.

And it is the real interest rate not the money rate that counts for economic growth.

Second, China s central bank still controls interest rates by enforcing a roughly three percentage point spread between deposit rates and lending rates.

America s Interest Rate Puzzle

Lower interest rates are not a solution to this dilemma.

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.

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

In May 2006, the fairly free domestic interbank rate was just 1.62 , while the US Federal Funds rate was 5 .

At present, the interest rate is less than 0.5 .

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.

But the interest rate that Greece must pay buyers of its government bonds has shot up to a record high level of nearly 9 5.9 percentage points above the benchmark rate paid by Germany.

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

Foreign investors then sent their money to New York to take advantage of the higher rates.

The interest rate on these totally safe and liquid deposits induced the banks to maintain excess reserves at the Fed instead of lending and creating deposits to absorb the increased reserves, as they would have done before 2008.

Likewise, increasing the interest rates paid on bank deposits would enable savings to decline without loss of income.

However, this is no longer applied since the central bank started changing rates by 0.25 percentage points on October 19, 2010 (which was a rate increase).

Low interest rates on deposits encourage savers, especially households, to invest in fixed assets, rather than keep their money in banks.

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

In Japan, the ten year rate has drifted to below 0.8 .

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

And that is important, because a rise in the federal funds rate will cause other, somewhat longer interest rates to increase as well.

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 .

Since the interest rate set by the ECB is now less than 1 , there is little difference between its current monetary policy and what the Bank of Spain would do if it could set its own interest rate. But when the euro zone starts to recover, the ECB might choose to raise the interest rate before a higher rate would be appropriate for Spain, which could exacerbate Spanish unemployment.

All the above assumes that the interest rate remains constant throughout the whole period.

Indeed, the interest rate on inflation protected bonds has now become 0.5 , even for a five year maturity!

Given today s exceptionally low long term interest rates, the annual cost would be, well, peanuts.

Thus, the market can establish the necessary interest differential only if interest rates on yuan assets fall below their dollar equivalents.

But such an insignificant rate hike will do little to relieve long term pressures, because investors will expect more rate hikes and move money into China, increasing upward pressure on the yuan s exchange rate.

But structured deposits for example, deposits whose rate of return is linked to the performance of the New York Stock Exchange are becoming increasingly popular.

The interest rate on ten year Treasury bonds has risen almost a full percentage point since February, to 2.72 , implying a loss of nearly 10 in the price of the bond.

This is intended to stimulate private spending by bringing down the rate of interest at which banks lend to their customers.

Yes, there is a minus sign in front of that if you buy the five year TIPS, each year over the next five years the US Treasury will pay you in interest the past year s consumer inflation rate minus 1.02 .

That predictable dollar decline makes the relative return on holding dollar bonds even lower than the interest rate differential alone implies.

The first, the Secular Stagnation Hypothesis, has been proposed by Larry Summers. Its key premise is that the equilibrium interest rate at which demand would balance supply is currently below the actual interest rate.

Likewise, the Bank of England keeps its policy rate at only 0.5 , despite an inflation rate that hovers above 2 .

A direct effect of the higher interest rate would be to increase the budget deficit and the rate of growth of government debt.

In the last month alone, Australia, India, Mexico, and others have cut interest rates. China has reduced reserve requirements on banks.

In 2012, the People s Bank of China allowed commercial banks to float interest rates on deposits upward by 10 from the benchmark, and on bank loans downward by 20 .

Monetary policy is now drawing on a more comprehensive toolkit, such as the policy rate, the interest rate corridor, required reserve ratios, and the reserve option mechanism.