# Real Interest Rate

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## Definition of 'Real Interest Rate'

The real interest rate is the interest rate adjusted for inflation. It is the rate of return on an investment after taking inflation into account. The real interest rate is important because it determines the purchasing power of money.

The nominal interest rate is the interest rate that is stated on a loan or investment. The nominal interest rate does not take inflation into account. The real interest rate is calculated by subtracting the inflation rate from the nominal interest rate.

For example, if the nominal interest rate is 5% and the inflation rate is 2%, then the real interest rate is 3%. This means that the purchasing power of money will increase by 3% over the course of a year.

The real interest rate is important for several reasons. First, it determines the real cost of borrowing money. If the real interest rate is high, then it is more expensive to borrow money. This can make it difficult for businesses to invest and for consumers to buy goods and services. Second, the real interest rate affects the value of investments. If the real interest rate is high, then the value of investments will decrease. This can make it difficult for people to save for retirement or for other long-term goals.

The real interest rate is also important for the government. The government uses the real interest rate to set monetary policy. Monetary policy is the use of interest rates and other tools to influence the economy. The government can use the real interest rate to stimulate the economy or to slow it down.

The real interest rate is a complex concept, but it is an important one to understand. The real interest rate affects the economy in many ways, and it is important to be aware of how it works.

In addition to the nominal interest rate and the inflation rate, there are two other factors that affect the real interest rate: the expected inflation rate and the risk premium. The expected inflation rate is the rate of inflation that people expect to occur in the future. The risk premium is the amount of extra return that investors require to invest in a risky asset.

The real interest rate is calculated as follows:

Real interest rate = nominal interest rate - inflation rate - expected inflation rate - risk premium

The real interest rate is important because it determines the real cost of borrowing money and the value of investments. The real interest rate also affects the economy in many ways. The government uses the real interest rate to set monetary policy.

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