Can Rates Rise in Deflation?

Capital-IntRates

QUESTION: Hi Marty

Can interest rates go higher during a deflationary period. You mentioned in your posts, deflation is gripping Europe and im assuming the same for Asia. Once velocity falls and growth rates contract, is there a possibility of rates going higher, because of taxation and investor demand for higher yields?

Thanks

ANSWER: Yes. It is strangely a bell curve. Hyperinflation takes place in new governments because they have nothing and can only print. In a mature government, interest rates can rise (1) booming economy with rising demand, or (2) a collapsing economy where nobody is willing to buy their paper so they are forced to pay higher rates due to the collapse in confidence. The former is normally aligned with a rising currency whereas the latter is associated with a collapsing currency. Every fundamental has two sides depending upon the capital flows.

This illustration shows it is really a bell curve. At some point rates take off as the economy turns down because confidence collapses.