A 5% interest rate sounds good. But what if prices rise 3%?
Ana saves €1,000 for a year
The bank pays 5%
After a year she has €1,050.
Prices rise 3%
What cost €1,000 now costs €1,030.
What she gained
She can buy only about 2% more than before.
The points to remember
- Real interest rate = nominal interest rate − inflation rate.
- The nominal rate is what the bank pays; the real rate is what your money gains in buying power.
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The real rate is the gap between two numbers, and it can be negative.
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Three made-up countries
| Country | Nominal rate | Inflation | Real rate |
|---|---|---|---|
| Corland | 5% | 3% | 5 − 3 = 2% |
| Tessaly | 4% | 7% | 4 − 7 = −3% |
| Halden | 1.5% | 1.5% | 1.5 − 1.5 = 0% |
Remember it as: Interest minus inflation. Below zero: savers lose.
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Who wins and who loses depends on the real rate.
A negative real rate
- Savers lose: their money buys less each year.
- Borrowers gain: they repay with money worth less.
- Borrowing and spending are encouraged: AD rises.
A high real rate
- Savers gain: their money grows faster than prices.
- Borrowers pay more in real terms.
- Borrowing and spending are held back: AD falls.
The points to remember
- Central banks watch the real rate: a negative real rate is expansionary even if the nominal rate looks high.
- Keep the sign: 15.4 − 19.9 = −4.5%, not 4.5%.
Paper 2 asked this in May 2026 for 2 marks; Paper 3 asks it for 1 mark almost every year.
Table 1. Monetary data
| Item | 2022 |
|---|---|
| Central bank interest rate | 15.4% |
| Inflation rate | 19.9% |
Using information from Table 1, calculate the real interest rate in 2022.
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How the 2 marks are given
| You write | Marks |
|---|---|
| The working (for example 10.15 − 9) and the answer (1.15%) | 2 |
| Only the answer, or only the working | 1 |