A Negative Equilibrium Interest Rate
Posted: 6 May 2003
Abstract
The average after-tax real interest rate on U.S. T-bills and the average rate of return on long-term government bonds (LTGB) have been negative over the last 75 years. Is this negative rate an equilibrium phenomenon or simply an empirical fluke? We show that a negative equilibrium interest rate is possible and that the wealthier the nation is, the more negative the equilibrium interest rate can be. This phenomenon results from a positive inflation rate and taxation of nominal profits, and it cannot hold in a period of zero inflation or in a period of deflation. A positive demand for T-bills and for LTGB exists also in a portfolio framework, even when these two assets are characterized by a negative expected rate of return and other assets are yielding positive expected returns.
Keywords: Investment Theory: portfolio theory, Portfolio Management: asset allocation
Suggested Citation: Suggested Citation
