Real Interest Rate

Course Outline

Dictionary of Economics

Course (113 videos)

Real Interest Rate

You likely hear the interest rate and inflation rate discussed all the time. But how are the two linked?

We cover that in this video on the real interest rate.

First off, it’s important to note that the real interest rate is the nominal interest rate minus inflation.

Ok, but what’s the nominal interest rate?

When you go to a bank to get a loan, they charge you an interest rate. For simplicity, let’s say you’ve gotten a small loan of $100 and the bank is charging you an interest rate of 10%. If you pay back the loan over a year, the bank will end up with $110 – $10 more than they loaned you.

Now, what we commonly call an “interest rate” is really the nominal interest rate. So that 10% is not taking inflation into account. If inflation for the year ends up being 10%, the bank doesn’t actually make a real return because of the decrease in the value of money.

Can you calculate the real interest rate on that $100 loan? Yep, it’s 0%.

In the video, we’ll cover the more complicated scenario of what happened in the U.S. in the 1970s when inflation was much higher than expected.

Teacher Resources


What is the real interest rate? Well, first let's start with what the nominal interest rate is. That's the interest rate you see on a bank or credit card statement. So when people say interest rate, they usually mean nominal interest rate. To see the difference between nominal and real interest rates, let's turn to an example.


Suppose that a bank lends $100 at a nominal interest rate of 10%, but suppose also that over the year the inflation rate is 10%. At the end of that year, the borrower pays back the bank $110. That looks pretty good on paper, but during the year, money has become less valuable. Due to inflation, what used to cost $100 now costs $110. So what is the bank's real return? Zero.



More generally, we can write that the real interest rate is equal to the nominal rate, the rate charged on paper, minus the inflation rate. Inflation reduces the real return on a loan. So unexpected inflation can redistribute wealth from the lender to the borrower, and that's exactly what happened in the 1970s in the United States.



Suppose, for example, that you had taken out a home mortgage in the 1960s. As a borrower, you'd have done really well because few people anticipated the high inflation rates of the 1970s. So borrowers ended up paying off their mortgages in dollars that were worth a lot less than anyone had expected.



As you can see, in order to understand interest rates, understanding inflation is crucial. If you'd like to learn more about inflation, click here. Or, if you'd like to test your knowledge on the real interest rate, click here.



Still here? Check out Marginal Revolution University's other popular videos.



Thanks to our awesome community of subtitle contributors, individual videos in this course might have additional languages. More info below on how to see which languages are available (and how to contribute more!).

How to turn on captions and select a language:

  1. Click the settings icon (⚙) at the bottom of the video screen.
  2. Click Subtitles/CC.
  3. Select a language.


Contribute Translations!

Join the team and help us provide world-class economics education to everyone, everywhere for free! You can also reach out to us at [email protected] for more info.

Submit subtitles




We aim to make our content accessible to users around the world with varying needs and circumstances.

Currently we provide:

Are we missing something? Please let us know at [email protected]


Creative Commons

Creative Commons License

This work is licensed under a Creative Commons Attribution-NoDerivatives 4.0 International License.
The third party material as seen in this video is subject to third party copyright and is used here pursuant
to the fair use doctrine as stipulated in Section 107 of the Copyright Act. We grant no rights and make no
warranties with regard to the third party material depicted in the video and your use of this video may
require additional clearances and licenses. We advise consulting with clearance counsel before relying
on the fair use doctrine.