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Real Interest Rate
Definition
The real interest rate is the nominal interest rate minus inflation, representing the true cost of borrowing or true return on savings.
Explanation
Real interest rates can be positive or negative. When inflation exceeds nominal interest rates, real rates are negative, meaning savers lose purchasing power. Central banks adjust policy rates to influence real interest rates and manage economic growth.
For borrowers, high inflation reduces the real cost of fixed-rate debt. For lenders and savers, high inflation erodes real returns if interest rates don't keep pace.
Example
A nominal interest rate of 6% on a savings account with 4% inflation yields a real interest rate of only 2%.