If the real interest rate is negative, it must mean that ______.

Question

BlackTom AI · Accepted Answer

Let’s unpack what negative real interest rates imply in macroeconomic terms and how they relate to concepts like the marginal product of capital.
Option 1: 'in the short run, bond rates can be very volatile.' This statement speaks to short-run fluctuations in bond yields, which can happen for many reasons (liquidity, risk premia, policy surprises). However, it does not directly address the relationship between negative real rates and the marginal product of capital, so while it may be true in some contexts, it’s not the central implication about a negative real rate, and thus not the best fit for the question’s focus.
Option 2: 'in the short run, the real interest rate equals the marginal product of capital.' In many classical or equilibrium theories, the real interest rate tends to align with the marginal product of capital in steady-state or long-run models, but the premise of a negative real rate creates a situation where frictions, financial conditions, or expectations can cause deviations. Therefore, this statement is too strong as a general claim and conflicts with the idea that short-run dynamics can diverge from the marginal product of capital when rates are negative.
Option 3: 'in the short run, the real interest rate can deviate from the marginal product of capital.' This aligns with models that allow for imperfections, expectations, and policy actions to push real rates away from the marginal productivity of capital in the short run. When real rates are negative, monetary policy, risk, and other factors can create a gap between the two concepts, making this option a plausible and widely taught implication.
Option 4: 'it is difficult to predict long-term interest rates.' While predicting long-term rates is indeed challenging in practice, this option doesn’t address the specific scenario of a negative real rate and its relation to the marginal product of capital. It shifts the focus to predictability rather than the relationship in question, so it’s not the most direct answer about the stated implication.
Option 5: 'there is no relationship between long- and short-term interest rates.' This is incorrect because, in most macro models, there is some linkage between long- and short-term rates through expectations, risk premia, and monetary policy transmission. The negative real rate scenario typically engages both horizons, and asserting no relationship neglects these channels.
In summary, option 3 captures the core idea that a negative real interest rate can be accompanied by a short-run deviation between the real rate and the marginal product of capital, reflecting the influence of frictions, expectations, and policy on short-run dynamics. The other options either misstate the core relationship or focus on peripheral aspects that don’t directly explain the question’s premise.

FA25 ECON 302 002 Midterm Exam #3 (Chapters 7-9): Sample Questions

If the real interest rate is negative, it must mean that ______.

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