Why do real rates ratchet downwards in a real monetary system?
First, lenders understand the problem of diminishing returns in a nominal monetary system, as set forth just above; so they add an inflationary premium to the interest rates offered to the general public. (They don’t wait a year or two to make a correction.) In a real monetary system, real financial instruments are self-adjusting for inflation; hence, they do not require an inflationary premium. This allows us to factor out the inflationary premium, which brings down the real rate of interest. Second, money is a commodity subject to supply and demand, just like any other commodity. By factoring out the inflationary premium from lending rates, we also reduce the payments made the borrowers. This reduces the probability of a loan default, so lenders lose less money as a result; thereby increasing their investment returns over time. This increases the funds available for new loans, which also contributes to bringing down real rates of interest. Finally, the nominal money supply is tightly
