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.
Real Interest Rate Formula
The following formula is used to calculate the real interest rate.
ir = i – e
- Where ir is the real interest rate
- i is the nominal interest rate
- e is the expected rate of inflation.
Real Interest Rate Definition
A real interest rate is the expected true interest rate of a loan or credit after inflation is taken into account. Since inflation occurs naturally in a healthy economy, you must take it into consideration when determining a real or true interest rate.
How to calculate real interest rate
Let’s look at an example of applying the formula above. Let 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 worthless at the end of the year, and so you will actually be paying more.
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