Question 5.4: Calculating the Real Interest Rate At the start of 2008, one...
Calculating the Real Interest Rate
At the start of 2008, one-year U.S. government bond rates were about 3.3%,while the inflation rate that year was 0.1%. At the start of 2011, one-year interest rates were about 0.3%, and the inflation rate that year was about 3.0%. What were the real interest rates in 2008 and in 2011?
Using Eq. 5.5, the real interest rate in 2008 was (3.3% – 0.1%) / ( 1.001 ) = 3.20%. In 2011, the real interest rate was (0.3% – 3.0%) / (1.03) = -2.62%.
Real Rate =\frac{\text{Nominal Rate – Inflation Rate}}{1 + \text{Inflation Rate}}\approx Nominal Rate – Inflation Rate (5.5)
Evaluate
Note that the real interest rate was negative in 2011, indicating that interest rates were insufficient to keep up with inflation: Investors in U.S. government bonds were able to buy less at the end of the year than they could have purchased at the start of the year. On the other hand, there was hardly any inflation.