Can the real interest rate be negative in a world where some but not all goods can be stored costlessly? Consider for illustration an economy with two goods, immortal potatoes and transient haircuts, with both items currently selling for $1 and both given equal weights in the CPI. If you put $2 into a 1-year TIPS with a real interest rate of -1% in that world, next year you’d have the ability to purchase 0.99 potatoes and 0.99 haircuts.
Why buy the TIPS when you could simply save the $2 in the form of 2 potatoes and still have those same 2 potatoes a year from now? If nothing else changes, and 2 potatoes were still worth 2 haircuts a year from now, everybody would want to do just that. If we were in long-run equilibrium before the real rate went negative, in response to a negative real interest rate, everybody would want to buy potatoes today as an investment vehicle. The price of potatoes today would have to be bid up to a point above the long-run equilibrium so that from here, potato prices are expected to rise less quickly than the price of hair cuts. Your 2 potatoes might be worth 2 haircuts today, but if they’re only worth 1.96 haircuts next year, you might be just indifferent between an investment in TIPS or physically storing the commodity.
Here is much more. Greg Mankiw, among others, has pointed out that we are seeing negative real rates of return in some credit markets. I don’t read this as a reflection of intertemporal preferences and constraints. I read this as a (scary) sign of how segmented some credit markets have become. More concretely, lots of people are running to Treasuries but out of a general sense of fear rather than from rational calculation. Right now rational calculation is very difficult, agency problems are causing people to avoid the possible blame that can result from risky assets, and credit market arbitrage isn’t much working. It’s no longer clear how much information prices are reflecting.