Calculate the real interest rate from the nominal interest rate and expected inflation rate by using the fisher equation. Real interest rates account for inflation.
The fisher equation is a formula used to calculate the “real interest rate” of a loan or credit. The real interest rate takes into account the expected inflation during the term of the loan using historical measures. In short, it will show you the true cost of borrowing money.
This term was first explored in 1930 by Irving Fisher, who the equation was later named after. The following is the fisher formula:
ir = i – πe
Whre ir is the real interest rate
i is the nominal interst rate
πe is the expected rate of inflation.
How to calculate real interest rate
Let’s look at an example of applying the formula above. Lest say you take out a loan with 7% interest. Next, the expected level of inflation is 2%. Now plug those values into the calculator or equation above, and you have an adjusted real rate of 5%. As you can tell, the real interest rate is lower than the nominal interest rate. As a result, this means that the money you borrowed will be worth less at the end of the year, and so you will actually be paying more.
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