Expected Real Interest Rate

And finance Allah shmoop what are really interest rates and

inflation Correction Riel interest rate of percent figure that tracks

her actual interest in any given conversation like you bump

into your old roommate and he starts talking about his

foot polyp riel Interest rate Fifteen percent He starts talking

about the time he was kidnapped by Basque nationalists while

on a yacht with Kate Upton Riel Interest rates yet

ninety five percent Well the more famous version of a

really interest rates have to do with finance It tracks

the rate of interest after subtracting the impact of inflation

Right So it's real It's not just nominal Your friend

wants to buy a pure bred show pig for next

year's County Fair It costs a grand but she doesn't

have the cash on hand so she borrows the money

from you You agreed alone the thousand dollars for one

year at fifteen percent annual interest That's the interest rate

written into the contract The nominal rate The loan has

to be paid back at the end of the year

Well meanwhile the inflation rate this year totals five percent

Prices on everything They're going up up up by an

average of five percent during those twelve months when the

money was borrowed So you alone the grand on January

one and buy the next December thirty one while you

get eleven fifty back That's fifteen percent nominal interest However

inflation has eaten into some of that profit for you

At least rent on your money every January you like

to buy a set of dinosaur shaped novelty T infuser

Sze to give away his New Year's gifts last January

you could buy a hundred tea infusions for thousand dollars

this New year's those same hundred T infuser is cost

a thousand fifty right The five percent inflation is at

work when you loaned the money out Well eleven hundred

fifty dollars could buy you one hundred fifteen t infuser

by the time you get the money back While eleven

fifty will only buy you about one hundred ten tion

fuse er's and you'll have to throw in about five

dollars of extra money to get the one hundred tenth

one of the math They're well Your money buys last

because of inflation The real interest rate takes into account

what you can buy with the money Write it subtracts

inflation from your rate of return So here is the

back of the envelope Way to calculate the rial interest

rate Take the nominal rate and subtract the rate of

inflation Yep that's it Bingo What's left over is the

real rate Very fancy The answer you get when you

do this calculation is approximate but it's an easy way

to get close See alone out the thousand dollars of

fifteen percent interest but inflation that years five percent So

fifteen minus five is ten in the rial interest rate

here Yes it's ten percent Well that checks out if

you don't count money as money but counted as what

you can buy with the money like T infuse er's

Last January one you loaned out enough money to buy

one hundred T infuser a thousand dollars back one An

infuser cost ten bucks each Now it's December thirty one

In the same year you got back enough money to

buy approximately one hundred ten T infuser Right You got

eleven fifty back but infuser is cost ten fifty each

Now Right five percent inflation One hundred fuses worth of

money last year turned into enough to buy one hundred

ten in futures this year one hundred to one hundred

ten That's ah ten percent net riel return That's the

rial interest rate When you're the lender inflation eats into

your profit What should be a fifteen percent return then

becomes a realty ten percent return because five percent of

our money got slurped up by higher prices On the

other hand well it can be helpful in the same

deal your friend is paying you back in currency That's

five percent easier to get arm or liquid When you're

a borrower inflation helps you pay off alone easier It's

why a lot of countries who are highly in debt

love having inflation because it makes their debt so much

easier to pay back That's why lenders have to keep

the inflation rate in mind when they're quoting raids for

what they'll lend money at So let's look at it

on a national scale Greece is in trouble yet again

The country needs like eighteen billion dollars in loans from

the World Bank just so it can afford the marbled

cleaning bill for the Parthenon The World Bank has to

decide what interest rate to charge Well inflation's been running

high lately Last year was eight percent Experts predict it

will be about that same level for the foreseeable Yes

we're totally making up these numbers with the real world

way lower than that Meanwhile the World Bank wants to

secure a really interest rate of five percent Well what

does it do Well it wants a five percent real

rate when inflation's aid so it has to set the

nominal rate that's going to charge Greece to about thirteen

percent That's by plus eight equals thirteen even in Greece

So what about inflation Correction Well inflation correction is the

process of taking inflation out of an equation You adjust

a figure to take inflation into account It's the process

you're using to determine the rial rate Will the nominal

rates thirteen percent inflations eight percent after correcting or adjusting

for inflation while you end up with a real rate

Then of yes five percent Grease takes its loan with

thirteen percent interest Now it can keep the Parthenon sparkling

clean and tracked all those tourists who keep it out

of bankruptcy And hopefully it'll bring in enough dough to

fix the Olympic Stadium next year Good luck with that 00:04:52.71 --> [endTime] grease