Final answer:
Negative real rates refer to a situation where the real interest rate, which is the nominal interest rate minus the rate of inflation, becomes negative. Option C, inflation erodes the value of savings, is the correct answer.
Step-by-step explanation:
Negative real rates mean that inflation erodes the value of savings.
When the rate of inflation exceeds the nominal interest rate, borrowers effectively pay less in real terms than the amount they borrowed, resulting in a decrease in the value of savings over time. This can discourage saving and lead to decreased investment, lower aggregate demand, and potentially a recession.
In extreme cases, negative real interest rates can mean that lenders (banks or other financial institutions) are receiving less in repayment than they lent out after adjusting for inflation. While this does not typically mean lenders are paying borrowers to take out loans, it does mean that the value they receive back is less in real terms. This can discourage lending and spending, potentially leading to a liquidity trap where monetary policy becomes less effective and aggregate demand is reduced, sometimes causing or exacerbating a recession.
It is important to note that deflation also affects this dynamic by making real interest rates effectively higher when nominal rates are unaltered, as the decreased price level increases the real value of money. The combination of negative real rates, deflation, and liquidity traps can create complex challenges for economic policy.