Quote from: tee-rex on April 18, 2015, 05:26:19 PM

Why in the first place you assume that in real life you will have the real interest rate the same for both inflation and deflation? In 10% deflation the real interest rate will necessarily be equal to or more than 10% (by definition, since nominal interest rate is always above 0). But this in no case means that in 10% inflation it should be the same 10% (which would amount to 20% nominal interest rate, if rates are taken as percentage points). I obviously cannot accept your allegation as being relevant to reality.

Because we are investigating the effect of inflation and deflation ALL ELSE EQUAL.
I tried to explain why the real interest rate is the real market price of the money loan market: it is the tension between offer and demand of BORROWING VALUE. If you borrow money (demand of loan), you are going to look at your REAL burden of the loan, and hence you will work with the *real* interest rate to see if you want to borrow or not. I hope you will agree that, say, to buy a car or a house, if you have an inflation of 5% and the loan is 8%, or if there is no inflation and the loan is 3%, you will consider its burden the same, and whether you will demand a loan or not will be decided the same in both cases.
So you see that the demand curve in the loan market will depend on the real interest rate as the "price level of loan".
In the same way, you can argue that in order to lend out money, you are going to want a REAL return on your money, and for similar reasons, the offer curve in the loan market will also depend on the real interest rate as the "price level of loan".
So they will cross at a given REAL interest rate, which is the market price setting in the loan market.

The true price in the loan market is the real interest rate, that's my whole point.

Now, why don't you seem to see this in reality ? Simply, because when we have actual deflation, or when we have inflation, the economic situation is different, prices are different and so on. You cannot compare the current economic situation (where there might be some slight deflation) to the economic situation in the 70ies when there was huge inflation. So you shouldn't be surprised that the real interest rate is also fluctuating in periods of deflation as compared to other periods of inflation.

But to take your example: if there would be a steady-state long term deflation of 10%, that would mean that we have a HUGE economic growth of at least 10%. In such a booming economy, the real interest rate would most certainly be more than 10%, because the AVERAGE economic growth would already be 10%.

Now, if the AVERAGE economic growth would already be 10%, independent of any deflation or inflation, every person in his right mind would never lend out any money for less than 10% (with a certain risk) in real terms. Because he could get that same return by buying a basket of shares that is "the average economy" which would carry much less risk than lending out to a specific person for a specific investment.

So yes, if the economic growth is a steady long-term 10%, interest rates would be at least 10% in real terms.
Also in your inflationary example.

Suppose that you would have a crazy central bank that targets 10% inflation, and that the economic growth is 10% steady state (remember "all else equal" so also economic growth). Then yes, people will want 10% return in real terms on loans, which comes down to a crazy 20% nominal rate.

But that's again, because you take crazy numbers.

And they are not so off the mark in fact. I remember in the beginning of the 80ies to having had savings accounts with a return of 14% for instance.