How do you find the real rate?
The real interest rate can be calculated by removing the inflation rate from the current nominal interest rate. The equation is extremely simple to calculate. You simply figure out the nominal interest rate and subtract the calculated inflation rate and you will have the real rate as a result. This calculation is commonly recognized as the Fisher equation. This calculation is extremely important for investors, borrowers, and just about anyone else who periodically focuses on interest rates for loans.
What is the current real rate?
The United States last reported that the real rate clocked in at approximately 3.5 percent, which happens to be up from 2.5 percent in 2018. Based on year-over-year comparisons dating back to 2008, the real rate is the highest it has been in over a decade. Global markets pay significant attention to the real rate at all times, along with tons of other information. It is important to become familiar with the real economic interest rate if you are planning on borrowing, lending, or investing.
Why is the real rate is important?
The real rate plays a significant role in allowing investors and borrowers to understand exactly what type of rate that they are going to get when factoring inflation into the equation. The Fisher equation allows economists to utilize the nominal rate to subtract projected inflation from the interest rate. This leaves us with the real rate. Borrowers will benefit from understanding how much they will owe in interest after subtracting inflation. This can be helpful to understand the costs of taking out a large financial loan. Borrowers might also be able to calculate how quickly they can pay back the money if they have an exact understanding of the real rate. Lenders will also benefit from having knowledge about the real interest rate. Lenders will get to learn about how much they are owed in interest after inflation is removed from the calculation. This can help lenders and investors understand how much real interest they have generated from an outstanding loan.
What was the real rate in 2020?
The real rate will likely remain at approximately 3.5 percent for 2020. There is some uncertainty about how much inflation may change with the current economic circumstances, but the real rate will likely remain similar to the last economic report that included the rate officially. Current projections show inflation for 2020 to remain near 1.0 percent, but the fourth quarter of 2020 will likely play a significant role in determining the actual real interest rate.
What does the nominal rate mean?
The nominal rate is an interest rate that doesn’t remove inflation projections from the formula. The nominal rate doesn’t adjust for compounding and also doesn’t adjust for inflation. Economists are always going to want to know the nominal rate so that they can plug it into the Fisher equation and generate the projected real rate. Utilizing the appropriate interest rate can be important for projecting financial buying power in the distant future. It can also help to understand exactly how much you are paying or earning in interest, compared to inflation.
Do nominal and real interest rates move together?
It is important to discuss how the nominal rate functions alongside the real rate. You might know by now that the real rate cannot really be projected without knowing the nominal rate and the projected inflation rate. Considering that we have to utilize the nominal rate and inflation rate to calculate the projected real rate, it is completely accurate to say that they do in fact move together. Divergence can exist in rarer economic scenarios where inflation is extremely high, but in most cases the nominal rate is only separated from the real rate by the projected inflation rate.
How do you calculate effective rate and nominal rate?
The effective interest rate can be calculated by using the nominal rate and dividing it against the time sequence that you desire. For example, if you wanted a monthly effective rate calculation, you would use the nominal rate and divide it by twelve. If you wanted the quarterly rate, you would divide the nominal rate by four. The Fisher equation is a formula that will be used regularly to calculate varying interest rates. We have learned a lot of different things about how the nominal and real rates effect each other. We have also learned about some of the positive benefits that borrowers and lenders can take advantage of when learning about these imperative economic interest rates.
Final Summary
We are now going to summarize all of the important topics that we discussed within this post. The nominal and real rates are extremely important for the economy to function properly. Investors are always keeping an eye on these rates to try and gain a better understanding of the current economic outlook. Take a look at some of the reasons that it is important for you to keep an eye on these interest rates as well.
Important Details about the Nominal and Real Economic Interest Rates
- The Real Economic Interest Rate tells you How Much Interest You are Generating without the Factor of Inflation
- The Real Economic Interest Rate can be Calculated by Using the Nominal Rate and Subtracting the Inflation Rate
- Understanding the Real Rate of a Loan can Effect Financial Earning Power in the Future
Real Interest Rate FAQ
What is real interest rate in economics?
Why real interest rate is important?
How do you calculate nominal interest rate?
How do you calculate real interest rate?
Can the real interest rate be negative?
What decreases the real interest rate?
What happens when real interest rate increases?
Further Reading
- Equilibrium real interest rates and the financial cycle: Empirical evidence for Euro area member countries – www.sciencedirect.com [PDF]
- Political regime change and the real interest rate – www.jstor.org [PDF]
- Demographics and real interest rates: Inspecting the mechanism – www.sciencedirect.com [PDF]
- Risk matters: The real effects of volatility shocks – www.aeaweb.org [PDF]
- Term structures of inflation expectations and real interest rates – amstat.tandfonline.com [PDF]
- Measuring international capital mobility: a review – www.jstor.org [PDF]
- Longer-run economic consequences of pandemics – www.nber.org [PDF]
- Measuring the natural rate of interest – www.mitpressjournals.org [PDF]
