The nominal interest rate cannot fall below zero because
A)inflation is generally too low.
B)financial markets do allow for arbitrage opportunities.
C)inflation is generally too high.
D)central banks are engaged in interest rate targeting.
E)financial markets cannot allow for arbitrage opportunities.

Question

Quizplus · Accepted Answer

The nominal interest rate can technically fall below zero, but the concept of negative interest rates challenges traditional financial market operations, where investors expect to earn rather than pay interest on deposits. The statement about financial markets not allowing for arbitrage opportunities is related to the idea that in efficient markets, negative interest rates would create unusual situations where investors might pay to lend money, which contradicts the normal pursuit of profit. However, the explanation provided is more aligned with the theoretical barriers to negative rates rather than arbitrage opportunities per se. Negative rates have been observed in practice, challenging the traditional notion that nominal rates cannot fall below zero.

The Nominal Interest Rate Cannot Fall Below Zero Because