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Brian D. Butler
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Definition
The "real interest rate" is the effective interest rate minus the inflation rate. By using the Real interest rate, you are correcting for inflation, and is calculated based on nominal interest rate mines the rate of inflation.
RIR = NIR – Inflation
Why its important?
Interest rates need to be higher than the rate of inflation. If not...then people dont have the incentive to save, but rather to spend. For example...the Vietnamese government raised interest rates in June '08 from 12% to 14%. But, even with this increase, the nominal interest rates are too low compared to inflation, and so "real interest" rates are in fact negative. This means that people are better off spending than saving because the money in the bank grows slower than inflation. But the pressure to spend rather than save is only fueling further inflationary pressures.
During inflationary periods, we must use real interest rates, not nominal or money interest rates, to calculate the yield on investment in terms of goods earned per year on goods invested. The real interest rate is approximately equal to the nominal interest rate minus the rate of inflation.
Shift to commodities
If real interest rates were very negative, investors could start investing in inventories of goods, but this arbitrage is not easy. But many economists claim that the reason behind the recent boom in commodities prices is that US real interest rates are negative. read more here
related KookPlan pages
Trends in the USA
Real interest rates turned negative in 2008
Brazil has highest Real interest rate in the world (2008)
Links from KookyPlan
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