Mike Larson examines what real interest rates are and what they mean for the economy. Mr. Larson takes a closer look at real and nominal interest rates and how they can affect the economy.

The Federal Reserve has been cutting interest rates. The benchmark federal funds rate was 5.25% last summer. It's all the way down to 2.25% now and, chances are, the Fed will cut that rate again when it concludes its next policy meeting on April 30. The only question is whether they will issue a quarter-point or half-point cut at that time.

Consider this: 2.25% sounds low, and it is. But what if interest rates, by at least one measure, are really -4.65%? Or that by another measure, they've hit a stunning -12.55%? These numbers are accurate:

Looking at the current, nominal level of rates along with what inflation is doing to get an idea of whether monetary policy is easy or tight is the concept of "real" interest rates versus "nominal" ones. When real rates are negative, it's a sign that policy is easy. That can drive inflation pressures and inflation expectations higher. When real rates are positive, it means that monetary policy is restrictive. That, in turn, tends to keep inflation controlled

Today the nominal federal funds rate may be 2.25%. But key inflation data released over the past several days shows:



Import prices skyrocketed 14.8% from a year ago in the month of March. That was up from 13.4% a month earlier and the highest rate of import inflation since the government started tracking it in 1982.

Producer prices jumped 6.9% from March 2007. That year-over-year gain in the Producer Price Index is just shy of the 7.4% rate in January, which, in turn, was the biggest rise since 1981.

The Consumer Price Index rose 4% since last March.

Computing the real funds rate using import prices results in a -12.55% rate (2.25% nominal funds rate minus 14.8% import inflation rate). Using the PPI, results in a -4.65% rate (2.25% minus 6.9%). Even using the CPI, real interest rates are still negative -- -1.75% (2.25% minus 4%).

Crude oil hit a fresh, all-time high of $115 a barrel this week and the price of many different commodities have gone through the roof while the dollar has continued to fall. This is not just strong demand. It's not just strong overseas economic growth. It's the fact that nominal rates are much lower in the U.S. than elsewhere and that real rates are hugely negative.

Larson believes, "Fed Chairman Ben Bernanke has abandoned any semblance of caring about inflation and decided that the real concern is fighting deflation by any means necessary, including slashing interest rates to as little as -12.55%. Investors are piling into commodities and fleeing dollar investments because they are desperately trying to maintain their purchasing power in the face of a Fed that appears dead-set on destroying it."

"You should put your money in investments that can protect you. That includes hard assets like gold and other commodities, Treasury Inflation Protected Securities (TIPS), and foreign bonds, which rise in dollar terms when the greenback loses value," Mr. Larson states.

To read this issue online, please visit:

http://www.moneyandmarkets.com/Issues.aspx?NewsletterEntryId=1677

About Mike Larson and Money and Markets

Mike Larson joined the company in 2001, and has more than 10 years of experience researching and writing about personal finance, investing, and the housing and mortgage industry. In 2003, Mr. Larson was named associate editor of the company's monthly Safe Money Report. In this role, he is responsible for writing and editing as well as analyzing trading opportunities for clients. Mr. Larson is also a regular contributor to the company's daily e-letter, Money and Markets.

Before joining Weiss Research, Mr. Larson was a personal finance reporter for Bankrate.com, where he wrote extensively on mortgage lending, banking, residential real estate, and Federal Reserve Board policy. His responsibilities included analyzing economic data and interest rate trends for a weekly column and developing rate forecasts for a regular index feature. Previously, Mr. Larson held positions at Bloomberg News and the Boston Herald.

Recognized as an interest rate and mortgage market expert, Mr. Larson's views have been quoted in the Washington Post, Chicago Tribune, Dow Jones Newswires, Reuters, Sun-Sentinel and the Palm Beach Post. He has also appeared as an investment expert to discuss the housing market on CNBC, CNN, and Bloomberg Television. His writing has been acknowledged by both the National Association of Real Estate Editors and the Massachusetts Press Association.

Among the first analysts to call the housing slide, Mr. Larson's new policy paper, "How Federal Regulators, Lenders and Wall Street Created America's Housing Crisis: Nine Proposals for a Long-Term Recovery" has received broad media coverage following its July 2007 submission to the Federal Reserve and FDIC. Mr. Larson holds B.A. and B.S. degrees from Boston University.

Money and Markets (http://www.moneyandmarkets.com) is a free daily investment newsletter from Dr. Martin Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Weiss Research, Inc. is located in Jupiter, Florida. For more information about our editors, or to set up an interview, please contact Jennifer Moran at 561-627-3300 or visit http://www.moneyandmarkets.com.

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