The real rate of interest is the nominal rate of interest adjusted for inflation. It represents the true cost of borrowing or the true return on lending after accounting for the impact of inflation on the purchasing power of money. In other words, it reflects the actual increase or decrease in the value of money over time.
For example, if a bank offers a nominal interest rate of 5% on a loan, and the inflation rate is 2%, the real rate of interest on that loan would be 3% (5% - 2% = 3%). This means that the borrower will actually pay an additional 3% of the principal amount in real terms for the use of the loan, after accounting for the reduction in purchasing power due to inflation.
The real rate of interest is important to consider when making investment or borrowing decisions, as it provides a more accurate picture of the actual return or cost of a financial transaction. A high real interest rate means that borrowing is expensive and may deter investment, while a low real interest rate makes borrowing cheaper and may encourage investment.
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