Question

You are considering purchasing a car, and you are offered a loan with a nominal interest rate of 5 %. Assume inflation is expected to average 2 % over the life of the loan. What is the real interest rate

Answer 1

The real interest rate is;

Real interest rate = nominal interest rate - inflation

What is inflation?

The rate at which prices increase over a specific time period is known as inflation. Inflation is often measured in broad terms, such as the general rise in prices or the rise in a nation's cost of living.

There are three main causes of inflation:

• demand-pull inflation: Demand-pull inflation, which economists define as "too many dollars chasing too few things," is the increasing pressure on prices that accompanies a scarcity in supply.
• cost-push inflation: When the cost of labor and raw materials rise, the overall price level will rise (inflation).
• built-in inflation: As employees anticipate an increase in compensation when the cost of products and services rises in order to maintain their standard of living, this is known as built-in inflation.

What is real interest rate?

A real interest rate reflects the rate at which current things are preferred over future goods over time.

The difference between the nominal interest rate and the inflation rate is used to calculate the real interest rate for an investment.

Real interest rate = nominal interest rate - rate of inflation (expected or actual).

To know more about the inflation, here

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