Negative Real Interest Rates

(08 June 2012)

Suppose that the US government wanted to build a rail tunnel between New York City and New Jersey. Given the large price tag, the US government would sell bonds to spread the cost of the project over many years.

Under normal circumstances, when the US government competes with other borrowers for funds, it would have to pay a positive real rate of interest on the amount that it borrows to build the rail tunnel.

Circumstances are not normal however. Demand is still so weak that the US Treasury can borrow at negative real interest rates, i.e. the real yield on Treasury Inflation Protected Securities (TIPS). To be clear, investors expect to take a loss when they buy US Treasuries, but investors keep buying them anyway because the alternatives are so much worse.

At the current real 10-year rate of negative 0.49 percent, if the US Treasury borrowed just enough to purchase 10,000 hamburgers today, then investors who bought those securities only expect to repaid enough to purchase 9,521 hamburgers over the next 10 years.

If that's not a good argument for Congress and Pres. Obama to enact a new economic stimulus package and run larger budget deficits, then I don't know what is.