Real Interest Rate

The ex ante real interest rate is the inflation-adjusted interest rate expected when a borrowing, saving, or policy decision is made. It compares the nominal interest rate with expected inflation over the same future period, rather than with inflation subsequently realised.

Calculation

Under the Fisher relation, the exact calculation is r = [(1 + i)/(1 + πe)] - 1, where i is the nominal interest rate and πe is expected inflation, both expressed as decimals. For ordinary policy analysis, it is approximated as r ≈ i - πe.

• If the nominal rate is 7 per cent and expected inflation is 4 per cent, the approximate ex ante real rate is 3 per cent.
• The exact value in this example is about 2.88 per cent, reflecting compounding.

Choosing the inputs

The nominal rate and inflation expectation must cover the same maturity or horizon. A real policy-rate proxy may use the policy repo rate, while analysis of household or business borrowing may use the relevant nominal lending rate.

• Expected inflation may come from official projections, surveys, market indicators, or forecasting models.
• The inflation measure should correspond to the prices relevant to the analytical purpose.

Interpretation and limitations

A positive ex ante real rate means the nominal return or borrowing cost exceeds expected inflation. Unlike the ex post real interest rate, it does not use subsequently realised inflation and therefore remains sensitive to errors in inflation expectations.

• A higher real interest rate can raise the real cost of borrowing and encourage saving, other conditions remaining unchanged.
• Its policy meaning depends on the neutral real rate, risk premia, liquidity conditions, and monetary-policy transmission.