Real interest rate

Definition

Real interest rate is the interest rate that has been adjusted for inflation to reflect the true cost of borrowing. It represents the real purchasing power of money earned from an investment or paid on a loan.

5 Must Know Facts For Your Next Test

1. Real interest rate is calculated by subtracting the inflation rate from the nominal interest rate.
2. It provides a more accurate measure of an investor's or borrower's profitability and cost.
3. A positive real interest rate indicates that the purchasing power of money increases over time.
4. Central banks monitor real interest rates to manage economic stability and inflation.
5. When real interest rates are negative, savers lose purchasing power over time.

Review Questions

• How do you calculate the real interest rate?
• Why is it important to consider the real interest rate instead of just the nominal interest rate?
• What does a negative real interest rate signify for savers?

Related terms

Nominal Interest Rate:

The stated interest rate on a financial product without adjustment for inflation.

Inflation Rate:

The percentage increase in the general price level of goods and services over a specific period.

Purchasing Power: The value of currency expressed in terms of the amount of goods or services that one unit of money can buy.