Expected Real Interest Rate

There’s a lot on in “expected real interest rate,” so let’s do some dissecting to figure out what’s going on (gross, but necessary).

Whether you’re taking out a loan and you’ll be paying interest to your lender, or you’re opening a bank account and you’ll be collecting interest from your borrower, you’re dealing with interest.

Interest is the cost of borrowing.

If an interest rate is “real,” it takes inflation into account. What’s "not real" are the actual numbers we see, called the nominal interest rate. Nominal interest rates don’t take inflation into account, which is important since inflation changes the actual value, or buying-power, of money. So “real” in “real interest rate” means that you’ll be looking at the actual value of interest, regardless of time and inflation fluctuations.

"Expected" implies that we don’t really know what the interest rate will be, but we’ll do our best at guessing. If you’re opening a bank account that promises regular returns in interest, then you can calculate your expected real interest rate pretty easily. But...if you borrowed money and your interest rate is variable...the expected real interest rate (the money you owe to the bank) gets much more complicated to figure out.