Real interest rate equals which of the following?

Real interest rate equals which of the following?

• A. The nominal interest rate minus the inflation rate.
• B. The nominal interest rate plus the inflation rate.
• C. The inflation rate.
• D. The money demand function.

Answer: (B)

Real interest rate measures how much your purchasing power grows after accounting for inflation. It is obtained by adjusting the nominal rate downward for the rise in prices, not by adding inflation. If the nominal rate is 6% and inflation is 2%, the real rate is about 4% (more precisely 1.06/1.02 − 1 ≈ 3.92%). So the standard idea is roughly nominal minus inflation. Why this makes sense: the nominal rate tells you how fast money grows in your account, but inflation erodes purchasing power. Subtracting inflation isolates the real gain in what that money can actually buy. The inflation rate alone doesn’t represent the full return after price changes, and adding inflation to the nominal rate would exaggerate the true growth. The exact relationship is given by the Fisher equation, but the simple rule of thumb is real ≈ nominal − inflation.

Real interest rate measures how much your purchasing power grows after accounting for inflation. It is obtained by adjusting the nominal rate downward for the rise in prices, not by adding inflation. If the nominal rate is 6% and inflation is 2%, the real rate is about 4% (more precisely 1.06/1.02 − 1 ≈ 3.92%). So the standard idea is roughly nominal minus inflation.

Why this makes sense: the nominal rate tells you how fast money grows in your account, but inflation erodes purchasing power. Subtracting inflation isolates the real gain in what that money can actually buy. The inflation rate alone doesn’t represent the full return after price changes, and adding inflation to the nominal rate would exaggerate the true growth. The exact relationship is given by the Fisher equation, but the simple rule of thumb is real ≈ nominal − inflation.