What is the real interest rate equal to?

What is the real interest rate equal to?

• A. Nominal rate minus inflation rate
• B. Nominal rate plus inflation rate
• C. Inflation rate minus nominal rate
• D. Inflation rate divided by nominal rate

Answer: (A)

Real interest rate shows how much your purchasing power increases after accounting for inflation. It is found by subtracting the inflation rate from the nominal interest rate. For example, if the nominal rate is 6% and inflation is 2%, the real rate is about 4%, meaning your money’s purchasing power grows by 4%. Adding inflation to the nominal rate would overstate the gain in purchasing power. Subtracting the nominal rate from inflation would give a negative or misleading figure in normal cases. Dividing inflation by the nominal rate produces a ratio, not the actual change in purchasing power.

Real interest rate shows how much your purchasing power increases after accounting for inflation. It is found by subtracting the inflation rate from the nominal interest rate. For example, if the nominal rate is 6% and inflation is 2%, the real rate is about 4%, meaning your money’s purchasing power grows by 4%.

Adding inflation to the nominal rate would overstate the gain in purchasing power. Subtracting the nominal rate from inflation would give a negative or misleading figure in normal cases. Dividing inflation by the nominal rate produces a ratio, not the actual change in purchasing power.