Real interest rates

Definition

Real interest rates are the rates of interest an investor expects to receive after allowing for inflation. It is calculated by subtracting the inflation rate from the nominal interest rate.

5 Must Know Facts For Your Next Test

1. Real interest rates adjust for inflation, reflecting the true cost of borrowing and the real yield on investments.
2. Real interest rates can be negative if the nominal interest rate is lower than the inflation rate.
3. They are crucial in evaluating the time value of money as they provide a more accurate measure of purchasing power over time.
4. Investors use real interest rates to make better financial decisions, particularly regarding long-term investments and savings.
5. Central banks monitor real interest rates to gauge economic conditions and guide monetary policy.

Review Questions

• How do you calculate real interest rates?
• Why are real interest rates important for understanding the time value of money?
• Can real interest rates be negative? If so, under what conditions?

Related terms

Nominal Interest Rate: The stated or advertised rate of interest before adjustment for inflation.

Inflation Rate: The percentage increase in prices over a specified period, usually one year.

Time Value of Money (TVM): The concept that money available now is worth more than the same amount in the future due to its earning potential.