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With most investment vehicles, there is an interest rate attached to the investment that lets investors know how much they can expect to gain on the transaction; this expected real interest rate is one way of measuring the interest rate against inflation. To calculate real interest rate, the inflation rate is subtracted from the nominal interest rate, or the rate investors are told when making the investment. Economic specialists commonly forecast inflation rates, and this is known as the expected rate. While the expected rate is normally calculated very carefully, the expected real interest rate may not be the same as the actual real interest rate, so investors should only use it as a prediction tool, rather than assume this will accurately determine an investment’s real interest rate.
Inflation and deflation are key figures in determining whether an investment is growing and in seeing how well the investment is growing compared to present economic conditions. Real interest rate, whether expected or actual, is equivalent to the nominal interest rate after the percentage of inflation or deflation has been deducted. For example, a 5 percent nominal interest rate minus 2 percent inflation results in a 3 percent real interest rate.
The expected rate comes in when investors, or anyone figuring out the real interest rate, use the expected inflation rate predicted by economics specialists. Expected inflation, which is generally close to the actual amount, is an educated guess based on figures such as the world economy, how banks are looking, and consumers’ perception of price increases or decreases. Expected inflation is not actual inflation, so this should only be used to plan for investments and investors should not assume this is the actual interest rate. Expected real interest rate is used only for future interest rate estimates and not present estimates, because then the actual inflation rate can be used.
Expected real interest rate can be dramatically different from the actual real interest rate, because of unexpected factors such as recessions or depressions. Other economically charged events, such as war or natural disasters, can affect inflation or deflation in ways that economists cannot predict. Commonly, the actual and expected real interest rate values are nearly the same but, because it is possible that the two will be very different, investors should never assume the expectedrate will be exactly the same as the actual real interest rate.