What Is the Difference Between Nominal Interest Rate and Real Interest Rate?

Effective Interest Rate / Real interest rate refers to the real interest rate at which depositors or investors receive interest returns after excluding inflation rates. Which country's real interest rate is higher, the creditworthiness of that country's currency is better, and the chance of hot money going there is higher. For example, the real interest rate of the US dollar is increasing, and the expectations of the Federal Reserve to raise interest rates continue, so the flow of international hot money to the United States is more obvious. There are many ways to invest, such as bonds, stocks, real estate, antiques, foreign exchange ... Among them, the bond market is the most sensitive to these and real interest rates. It can be said that the exchange rate of the US dollar basically follows the trend of real interest rates.

Real interest rate

What is the meaning of the real interest rate, and how this rate is adjusted to fit it in

Simply put, the real interest rate is subtracted from the surface interest rate

use

Fisher's concept of real interest rates has two important implicit implications. First, the sacrifice is to achieve a balance by obtaining a series of consumer goods and services at some future date. These consumer goods and services depend on the assets created through investments that are currently financed by savings. Second, the real interest rate determines the proportion of resources used to produce capital goods and used to produce consumer goods.

Both implicit meanings mean that what people think of real interest rates has a significant impact on savings and investment and how they are used. In the minds of those who make decisions about saving and investment, long-term real interest rates are the most relevant, because capital goods go through a long life. Moreover, since these decisions depend on what people expect to happen in the future, what should be used as an adjustment factor for the nominal interest rate is not the past or present inflation rate, but the expected long-term inflation rate.

Given the importance of economic agents' decision on long-term real interest rates, this change in interest rate levels has profound implications. If its level rises, the present value of claims in the future will fall, and as a result, the value of personal property will fall. If its level drops, the opposite will happen. As for the effect of rising and falling real interest rates on the value of any particular asset, it varies according to the durability of the asset. As long-term real interest rates rise, individuals with more durable assets will lose more on the present value of their assets than individuals with less durable assets. If long-term real interest rates fall, their benefits will be greater.

Changes in long-term real interest rates are the result of a combination of changes in nominal interest rates and changes in expected inflation. When measuring the expected rate of inflation, a basket of goods, such as the consumer price index or the wholesale price index, is usually referred to. However, several reasons have been cited against the use of these indices.