Wednesday, November 9, 2011

A Model Of Persistently Negative Interest Rates

For those of you, like me, who are trying to better understand economics, here's a good thought experiment.--SS

A Model Of Persistently Negative Interest Rates:

Steve Randy Waldman offers a brief sketch of an economy in which interest rates would always be negative:

Suppose that land to grow wheat is scarce but labor to farm and bake it into bread is abundant. Land-owners and laborers are paid their marginal products, which at the limits of land scarcity and labor abundance means that land-owners receive approximately all the bread and laborers receive approximately none of it. Suppose that people prefer a bite of bread now to a bite of bread later, but that in each period, no individual can eat more than twice what their share of total output would be if total output were evenly divided. Land owners at full gluttony can eat no more than a small fraction of potential output, and they cannot store the surplus. Technology and population are stable, but land owners face negative real interest rate. There are laborers who would be glad to borrow the surplus bread, but they have no capacity to repay. The real interest rate on the bread lending market would be -100%.

Obviously, that’s not the economy of the real world. But it’s illuminating to think about.

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