tutor2u | Real Interest Rates

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Real Interest Rates

Level:
AS, A Level, IB
Board:
AQA, Edexcel, OCR, IB, Eduqas, WJEC

Last updated 14 Mar 2020

This short revision video looks at the concept of real interest rates on savings and loans.

Real Interest Rates

What is the real interest rate?

The real interest rate is the nominal interest rate adjusted for inflation

For example, if inflation is 4 percent, and the nominal interest rate on a loan is 6 percent, then the real interest rate = +2 per cent

Ceteris paribus, a higher real interest rate is good for savers but bad for borrowers especially those who have taken out big loans

Real interest rates can be negative e.g. if the annual rate of price inflation is higher than the nominal interest rate

The current Bank of England base rate (March 2020) is 0.25%.

It was cut on 11 March 2020, after staying at 0.75% since 2 August 2018.

The Bank of England said the move was to help households and small businesses affected by the coronavirus.

With consumer price inflation at 1.8%, then the real base rate of interest is negative

But many borrowers pay much higher nominal interest rates than this

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