Quote from: tee-rex on March 27, 2015, 09:08:10 AM

Let's say we have a zero real interest rate to simplify matters, since it is the same for both inflation and deflation. Also, we started with a condition that we are profitable at 0% inflation. What will your example be in these conditions, for inflation and deflation, please.

Of course, the real interest has to be larger than the deflation rate (which it normally is). Otherwise, you will never get a loan !

But if you really want to do the calculation, which is silly, we can:

Suppose that you are profitable with 2% value increase. That is, with no inflation, you will buy stuff for $1000, and you will sell it at $1020,-, you'll make $20 of profit.

Now consider 5% inflation. The interest you now pay is 5% on your loan. So you borrow $1000, and you have to pay $50 on it.
You will be able to sell your stuff for $1070,- because of inflation.

So you sell it for $1070, you pay $50 interest, and you pay back your loan of $1000. Profit: $20.

Consider now 5% deflation. We are now in the crazy situation where the actual interest is negative: you borrow $1000, and you'll have to pay negative interest: you will only have to re-imburse $950 (this is why you won't get a loan if the deflation rate is higher than the real interest rate).

You can sell your stuff now for $970. You pay back your loan of $1000, and you receive $50 (your negative interest).

Net profit, again: $20,-.

Point is, that in a real economy, with fixed money supply, the real interest rate can never be lower than the deflation rate (which is equal to the economic growth). Indeed, you don't want an interest rate that is lower than the *average* economic growth, do you !