"Why would a lender initiate a loan with a negative nominal rate of return? Wouldn't it be a better "investment" to simply place the
money under a mattress?"
Andrew: That's exactly the problem. When money is a depreciating asset (inflation), no one wants to hold it. Hence, undersaving results. Likewise, when money ia an appreciating asset (deflation), banks and consumers hoard money, and a deflationary spiral is underway. This is exactly what is happening in Japan. Their deflation is not from a shortage of money, but rather from a shortage of ways in which to employ it profitably, because of oversupply of manufactured goods.
But, regardless of the cause, when the currency itself is changing value, serious economic distortions result.
Perhaps in a perfectly competitive market, all prices, including principal payments and interest rates, inventory valuations, balance sheets, profit and loss statements, etc., could be mathematically adjusted to make everything "doable" under deflation. But, in the real world, some always have more bargaining power than others. Non-union workers, small businesses, small banks, etc., get creamed.
Any monetary "reform" must increase the money supply enough to accommodate economic growth, so as to maintain near price stability.
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