how to calculate real interest rate as possibe
how to calculate real interest rate
Tuesday, July 7, 2020
When you borrow or borrow, you usually do so in dollar terms. When you take out a loan, the loan is split into Dollars, and your promised payments are made in dollars. This dollar flow should be adjusted in order for inflation to calculate cash payments in real terms. The same point holds if you are a lender: you need to calculate the interest you earn on savings by adjusting for inflation.
The Fisher equation provides a link between equity and real interest rates. To convert from interest rates to real interest rates, we use the following formula:
real interest rate
To find the real interest rate, we take the real interest rate and subtract inflation. For example, if a loan has an interest rate of 12 percent and an inflation rate is 8, the real return on that loan is 4 percent.
In calculating the real interest rate, we used the real inflation rate. This is appropriate when you wish to understand the real interest rate payable under a loan contract. At the time of the loan agreement, however, the rate of inflation in the future is uncertain. Instead, the borrower and the borrower use inflation expectations to find interest rates on the loan. From that perspective, we use the following formula:
contractual interest rate ≈ real interest rate + interest rate increase.
We use the name of the contractual arrangement of the tangible contract to make it clear that this is the rate set at the time of the loan agreement, not the actual interest rate received.
Key Key
To adjust the inflation rate, subtract the inflation rate at the interest rate.
More Usually
Consider the two people who write a P loan loan agreement at interest rates a. This means that next year the adjusted value will be P × (1 + i). This is a standard loan contract with an interest rate i.
Now assume that people decide to write a loan contract to return the actual return (in terms of assets and not dollars) means r. So the contract provides P this year with a return on capital (enough dollars to buy) (1 + r) units of gross domestic product (real GDP) the following year. To repay this loan, the borrower gives the borrower enough money to buy (1 + r) units of real GDP per unit of actual borrowed GDP. So if the inflation rate is π, then the inflation rate is up to P × (1 + π), then the repayment on P loan dollars will be P (1 + r) × (1 + π).
Here's one (1 + π) and inflation rate. Inflation rate πt + 1 is defined - as usual - as a percentage change in the price level from period t to period t + 1.
πt + 1 = (Pt + 1 - Pt) / Pt.
If the period is one year, then the price in the following year equals the price for this year multiplied by (1 + π):
Pt + 1 = (1 + πt) × Pt.
The Fisher equation states that the two contracts should be equal:
(1 + i) = (1 + r) × (1 + π).
As an equation, this method of measurement is mean
is ≈ r + π.
a = r + π + rπ.
If r and π are small integers, then rπ is a very small number and can be safely ignored. For example, if r = 0.02 and π = 0.03, then rπ = 0.0006, and our estimate is about 99 percent accurate.