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Real Interest Rate

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A real interest rate is an interest rate adjusted for either current or expected inflation. According to the Fisher equation, the real interest rate is defined as the nominal interest rate minus the expected rate of inflation. Thus, the real interest rate can be negative if inflation is greater than the nominal interest rate. A negative real interest rate is not strictly academic; it has occurred. A real interest rate can also be higher than the nominal interest rate when deflation occurs. Deflation is potentially a very serious macroeconomic problem because the relationship between the nominal and real interest rate constrains monetary policy. For practical reasons, nominal rates don't go below zero. At a nominal interest rate of zero, the real interest rate is as high as the rate of deflation, and that positive real interest rate may be too high to encourage growth that might help end the deflation. A real interest rate will usually be explicitly labeled as a real interest rate, so an unspecified quoted interest rate is probably a nominal rather than a real interest rate.



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