Graph showing Real Interest Rates
Real Interest rates in UK
Source: Bank of England, 2005, p. 11, Chart 3 via – open learning
Real interest rates is the official interest rate – inflation.
If interest rates are 1% and inflation is 0.2%. Then the real interest rate is 0.8%
If interest rates are 12% and inflation is 13.5%. Then the real interest rate is -1.5%
In other words, a saver is better off with interest rates of 1% and inflation of 0.2%
At the moment, we have negative real interest rates because the base rate is 1% and inflation is 4% (though coming down)
However, many commercial banks have not followed the base rate down. So savers can still find saving accounts which offer a positive real interest rates.
The real interest rate is important for determing the real cost of borrowing and saving. A high real interest rates will, ceteris paribus tend to discourage borrowing and spending.
However, in a credit crunch a negative real interest rate may still be insufficient to encourage borrowing and lending because there is a shortage of credit.
See also: Historical interest rates
Am I the only person to tempted to borrow huge amounts of money at 1% and stick it into a FTSE100 index tracker over 20 years? Surely it’d be worth the gamble.
Alas, if the banks won’t lend money for a 2-bed in Norwich, I doubt they’ll give me £1million for an equity punt.
Consumers turn out to be not as simple as economists think.. just because inflation is up and interest is down – a nervous public is not going to break out their savings and buy stuff for the sake of it…
Economics is an art not a science, pity the government has not worked that out yet – they must be scratching their collective heads saying ‘why won’t the b*ggers spend??’
When we are in a crises like this, it is actually the savers and pensioners that are loosing the most, as their money is sitting in the bank getting no interest on their investment, which is very sad. Inflation really has to move down in order for them to benefit a little on their savings.
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