Real Interest Rate Calculator

Introduction

The Real Interest Rate is the interest rate we get after removing the effects of inflation from the nominal interest rate. The real interest rate calculator will help you quickly and accurately calculate the real interest rates.

The nominal interest rate is the rate that the bank would advertise and the rate you would pay on a loan from a bank. Inflation is the increase in prices of goods and services over a given period. Inflation helps us measure how much money it takes to buy the same goods and services over a period of time.

The Real Interest Rate is the increase in purchasing power that the lender can expect when the borrower repays the loan.

If inflation is higher than the nominal interest rate, it will result in a negative interest rate. When this happens, the lender will lose buying power, meaning the currency will buy lesser amount of goods than it previously could.

How to use Real Interest Rate Calculator?

Using the Real Interest Calculator, you can calculate the real interest rate, nominal interest rate, and inflation by inputting the other variables required for the calculation.

The variables in the calculator are:

Nominal Interest Rate (N)
The advertised interest rate by the bank or the interest rate you would pay for a loan from a bank.

Inflation Rate (Actual or Expected) (I)
The overall rate of increase of prices and goods and services over a given period of time.

Real Interest Rate (R)
The interest rate that we get after removing the effects of inflation from the nominal interest rate. You could also think of the real interest rate as the return the bank or lender receives after accounting for inflation when issuing debt.

How is the Real Interest Rate Calculated?

There are two ways to calculate the real interest rate: an approximation and the actual formula.

Let’s first look at the actual formula.

\text{Real Interest Rate} = \bigg(\normalsize \dfrac{1 + \text{Nominal Interest Rate}}{1 + \text{Inflation Rate}} \bigg) - 1

The above formula is actually called the Fisher equation. The Fisher equation describes the relationship between real and nominal interest rates under inflation. It is named after the American economist Irving Fisher.

Now, let’s look at the approximate formula, so if the nominal interest rate and the inflation rates are relatively low, we can use this approximation

\text{Real Interest Rate} = \text{Nominal Interest Rate} - \text{Inflation (Actual or Expected)}

Examples

For example, let’s say Person A borrowed 100,000 from Person B for a year. The nominal interest rate is 5% and Inflation is 2%. Then the Real Interest Rate is approximately 3%.

Actual Calculation

\begin{aligned} \text{Real Interest Rate} &= \bigg(\normalsize \dfrac{1 + \text{Nominal Interest Rate}}{1 + \text{Inflation Rate}} \bigg) - 1 \\[10pt] &= \bigg(\normalsize \dfrac{1 + 5\%}{1 + 2\%} \bigg) - 1\\[10pt] &= 2.941\% \end{aligned}

Approximation

\begin{aligned} \text{Real Interest Rate} &= \text{Nominal Interest Rate} - \text{Inflation (Actual or Expected)} \\[10pt] &= 5\% - 2\% \\[10pt] &= 3\% \end{aligned}

Now, let’s suppose the same scenario but this time the inflation is 6%. Then in this case there will be a negative interest rate of approx. 1%.

Actual Calculation

\begin{aligned} \text{Real Interest Rate} &= \bigg(\normalsize \dfrac{1 + \text{Nominal Interest Rate}}{1 + \text{Inflation Rate}} \bigg) - 1 \\[10pt] &= \bigg(\normalsize \dfrac{1 + 5\%}{1 + 6\%} \bigg) - 1\\[10pt] &=-0.943\% \end{aligned}

Approximation

\begin{aligned} \text{Real Interest Rate} &= \text{Nominal Interest Rate} - \text{Inflation (Actual or Expected)} \\[10pt] &= 5\% - 6\% \\[10pt] &= -1\% \end{aligned}

There is also the possibility that there is negative inflation or deflation. This would result in the real rate of interest being higher than the nominal rate of interest.