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What Is a Negative Real Interest Rate?

K.C. Bruning
K.C. Bruning

A negative real interest rate is a condition where inflation is higher than current interest, which means that the real interest rate is below zero. Real interest rates are calculated by taking the nominal rate of interest and subtracting inflation. The most significant effect of a negative real interest rate is that low-risk savings options such as bonds, certificates of deposit (CDs), and savings accounts have nearly no return.

When there is a negative real interest rate, it typically happens due to a downturn in the economy. Despite the low rate of return on savings, banks usually do not raise interest rates. This is because raising rates adds to the financial load of loan holders, which could further depress the economy and make recovery more difficult.

Man climbing a rope
Man climbing a rope

There are several common situations that can arise out of a negative real interest rate. As savings get a low rate of return when this happens, people are often less likely to save. On the other hand, they may save even more in order to compensate for future lost savings income due to the low rate. Many people also borrow more when there is a negative real interest rate in order to take advantage of low loan rates. A low return on savings can lead to an increase in spending overall.

As a negative real interest rate can affect the value of a country’s currency, the perception of the currency may change. It may have less value in comparison to currencies in other countries. People may also look to purchase precious metals such as gold and other commodities that maintain their value over time in order to make the most of savings. Others may purchase inflation-protected securities.

A real interest rate is determined by subtracting the inflation rate from the nominal interest rate. In essence, the nominal interest rate is the rate of interest before inflation has been considered. This information is determined with the calculation of the Fisher equation, in which one plus the nominal interest rate is equal to one plus the real interest rate multiplied by one plus the expected inflation rate. When the real interest rate has been found, then it can be determined if there is a negative real interest rate, which is indicated by a negative solution to the equation.

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