The problem for investors comes when real interest rates are negative, when the nominal interest rate won't keep up with inflation.
WSJ: Savviest Investors Pay Close Attention to 'Real' Interest Rates
In 2004, Portugal's economy grew by 1%, Ireland's by almost 5%, but both had the same nominal interest rate.
Because all member states share the same nominal interest rate, slow-growing economies with lower inflation, such as Germany and Italy, have higher real interest rates than fast growers, such as Spain and Greece.
Although the interest rate is 0% to 0.1%, average deflation of -1.3% in the past 15 years means that the real interest rate (nominal interest rate 0% minus the price change of -1.3%) is a positive 1.3%.
My good friend and sometime mentor, Brian Wesbury, argues that the natural rate of interest is the same as the nominal GDP growth rate.
Some suggest the Swiss ought to announce a peg to the euro or engineer a negative nominal interest rate.
So, if we observe an economy, in which the interest rate was below the nominal growth rate and inflation was not increasing what might we conclude?
Now to be clear I think the primary driver of low interest rates across the board is the presumption of weak nominal growth and that weak growth leading the Federal Reserve to keep a low interest rate target.
David Woo, a currency strategist at Bank of America Merrill Lynch, says that markets are now moving on real (after inflation) interest rate differentials rather than the nominal gaps they used to heed.
You need to read the speech for the full explanation, but the basic idea is that higher inflation can help push down the real cost of borrowing - the real interest rate - at times when nominal interest rates can't go any lower.
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