Zero rate of interest 

Zero rate of interest 

Subject :Economy

Section :Monetary Policy

Context:

If India has to move to 0 per cent real rate, that is inflation – interest rate = 0, we need 1 per cent increase in the rate of interest, says Uday Kotak, CEO and Managing Director of Kotak Mahindra Bank, on Sunday

Concept: 

Real rate of interest

A real interest rate is an interest rate that has been adjusted to remove the effects of inflation to reflect the real cost of funds to the borrower and the real yield to the lender or to an investor.

The calculation used to find the real interest rate is the nominal interest rate minus the actual or expected inflation rate.

Suppose a bank loans a person Rs 200,000 to purchase a house at a rate of 3%—the nominal interest rate not factoring in inflation. Assume the inflation rate is 2%. The real interest rate the borrower is paying is 1%. The real interest rate the bank is receiving is 1%. That means the purchasing power of the bank only increases by 1%.

Nominal interest rate

A nominal interest rate refers to the interest rate before taking inflation into account. Nominal can also refer to the advertised or stated interest rate on a loan, without taking into account any fees or compounding of interest.

The nominal interest rate is a simple concept to understand. If one borrows Rs100 at a 6% interest rate, they can expect to pay Rs 6 in interest without taking inflation into account.