Interest Rates, Nominal, Real

Easy way is nominal rate - interest rate

How to calculate real interest rate?

Government actions Federal Reserve Monetary Policy (Fed Funds) Supply (Households and Government) Demand (Businesses and Government) Expected rate of inflation

In equilibrium, interest rates are determined by:

The number you see everywhere. The number thats listed or quoted.

Nominal rate

CF/(1+r). So if rate of borrowing money goes up, stock price goes down.

Price of Stock

The real interest rate. The nominal rate accounting for inflation.

Real Rate

Inflation is caused when too much money is chasing too few goods The Fed raises interest rates to lower the money supply by making money more expensive to obtain Impacts investment and consumption (i.e., cash flows) Typically, raises in the Fed Funds Rate are associated with increases in the rate on T-Bills and Bonds i.e., the risk-free rate increases The required return on risky investments also increases

The Fed controls inflation using the Fed Funds Rate

Real rate + inflation forecast r + E[i]

What is nominal rate that you would want (R)

Monetary policy is formally set by the Federal Open Market Committee (FOMC) 12 voting members, composed of: All 7 members of the Federal Reserve Board 5 of the 12 Federal Reserve Bank presidents Committee meets 8 times per year

Who changes the interest rate?