Suppose the nominal interest rate on a one-year car loan is 8% and the inflation rate is expected to be 3% over the next year. Based on this information, we know:
The only thing that we can know for sure is that the real interest rate on the car loan is 5%.
The real interest rate equals the nominal interest rate - the inflation rate. This formula follows the Fisher Effect proposed by Irving Fisher and used to determine both nominal and real interest rates, and how they relate to the inflation rate.
