Subtract the rate of inflation from the rate of interest, and you get what they call the "real" interest rate.
Subtract the inflation rate from a "nominal" rate, and you get a "real" rate. That's the arithmetic of it.
You may have questions about GDP and interest rates, and the economy, and even about this calculation, but you cannot challenge the arithmetic. It works.
Our topic is the interest rate. The arithmetic allows economists to say things like this:
Since the global financial crisis, short-term nominal interest rates in many developed economies have hovered around zero. Similarly, inflation rates have been quite low by historical standards, although they have remained positive and roughly stable on average in most countries. As a consequence, real interest rates—defined as nominal rates minus expected inflation—have also been very low, even falling negative for some countries.
Now I have a problem. I don't have a problem with the first two sentences, which provide facts. My problem is in the third sentence. But the problem is not about how to calculate real interest rates, which is comparable to what I started with, above. Nor is the problem with their observation that real interest rates have been very low; this is simply the result you get from the calculation. My problem is with the first three words of the third sentence; in particular, the third word:
CONSEQUENCE
It is simply the wrong word. It implies that real rates are low because interest rates and inflation are low.
Nay, not "implies". It says as much.
Consequence is defined as a result or effect of an action or condition. To say that interest rates and inflation are low and, as a consequence, real rates are low, is to say that real rates are a result of interest rates and inflation. The result, that is, of the subtraction. This is absurd.
The whole discussion that economists have been having, about the real rate of interest, is an important discussion. If the economists are right, if the real rate is low and stays low, our economy will not be the same. Economic growth will be slower, for one thing.
What's that you say? Growth has been slow for a decade, you say? Yes, indeed; and this is intimately related (if those economists are right) to the fall of the real interest rate to a low level. (I keep interrupting myself to say "if those economists are right" not because I'm challenging them, but to make it clear that I am presenting their view. Not my view. I don't have a "view" on this. I don't yet know what my thoughts are.)
So when you say "Growth has been slow for a decade", what you are saying is that it's a good thing economists are looking into this "low real rate" thing.
I mean to create the impression that the real rate is a factor of great importance for the economy. The "real" interest rate is a key real-world factor. Obviously it is not simply the "consequence" of the subtraction. It exists, if these economists are right, and it is powerful enough to make economic growth go from bad to worse.
We know the value of the real interest rate because of the subtraction. Actually, the real interest rate is not "observable". It cannot be measured; it can only be calculated by working backwards from observable things. That's what the subtraction does: it gives us a number for the real interest rate by working backwards from inflation and the nominal rate.
But the fact that we can work backwards to get the number tells us that the real rate exists, if those economists are right. They see it as a driving force, a force that causes the value of the nominal rate to be what it is, given inflation.
But if this is true, if the real interest rate is a driving force, then surely it is wrong to say the value of the real interest rate is a "consequence" of inflation and the nominal rate. The real rate is cause, not consequence. We know the value of the real rate as a result of the subtraction; this is certainly true (if those economists are right). But the value of the real rate is not a "consequence" of the subtraction, nor of the nominal rate and inflation.
Let me take their third sentence and shorten it:
As a consequence, real interest rates have been very low.In that form, I find the sentence unacceptable. But in this form it is completely acceptable:
As a consequence, we know that real interest rates have been very low.We know, because of the subtraction. We know, because of the values of inflation and the nominal rate. Our knowledge is a consequence of these things. But the real rate is not.
If those economists are right.
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