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More on the puzzle of negative interest rates

More on the puzzle of negative interest rates

Interest rates on many bonds have plunged into negative territory. But why on earth would anyone be willing to save $1000 only to get $999 in the future? Saving up for a rainy day has always gone hand in hand with a positive interest rate, not a negative one.

In my last post I showed how negative real return on saving could emerge. I invoked a certain type of a economy – a dystopic island where castaways like Robinson Crusoe live. The island’s few meagre opportunities to invest have dried up. Technological advancement has halted. To prepare for his retirement Robinson Crusoe stores coconuts, but the constant assault from rodents and insects meant that he’d end up with less resources than he started with.

Crusoe and other castaways his age can also prepare for old age by lending resources to the island’s younger generation. But if the young are dying out, then the much larger cohort of older islanders will have to offer the few remaining young a lower – even negative – interest rate to coax them to borrow.

A tale of two interest rates

Our world is certainly experiencing many problems. But it doesn’t seem to correspond to the grim reality of a decaying Robinson Crusoe world. Sure, we are getting older and having fewer kids. But it’s hard to argue that technological advancement has ground to a halt or that projects are so non-productive that we are content to earn 0%.

For evidence, take a look at a chart of the rate of return on U.S. business capital:

 …click on the above link to read the rest of the article…

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