How does Inflation Affect the Real Interest Rate?
Inflation can affect real interest rates in the following ways:
- When the inflation rate is higher than the nominal interest rate (the interest rate quoted before accounting for the effects of inflation), the real interest rate (the interest rate that considers the impact of inflation) will be negative. This means that the purchasing power of the money you receive from the loan or investment will be less than the purchasing power of the money you paid out.
- The real interest rate will be positive if the inflation rate is lower than the nominal interest rate. This indicates that the amount of money you borrow or invest will have a higher purchasing power than the amount you pay out.
- The real interest rate will be zero if inflation is at the same rate as the nominal interest rate. This indicates that the buying power of the money you get as a result of the loan or investment will equal the purchasing power of the money you disbursed.
Nominal vs Real Interest Rates
The portion of a loan that is charged to the borrower is called an interest rate, and it is often stated as an annual percentage. Lenders utilize interest rates to cover the risk they assume when making loans, and they can also be used to help keep inflation under control.