ShmoopTube

00:00

And finance Allah shmoop what are really interest rates and

00:06

inflation Correction Riel interest rate of percent figure that tracks

00:12

her actual interest in any given conversation like you bump

00:15

into your old roommate and he starts talking about his

00:17

foot polyp riel Interest rate Fifteen percent He starts talking

00:21

about the time he was kidnapped by Basque nationalists while

00:24

on a yacht with Kate Upton Riel Interest rates yet

00:27

ninety five percent Well the more famous version of a

00:29

really interest rates have to do with finance It tracks

00:33

the rate of interest after subtracting the impact of inflation

00:37

Right So it's real It's not just nominal Your friend

00:40

wants to buy a pure bred show pig for next

00:42

year's County Fair It costs a grand but she doesn't

00:45

have the cash on hand so she borrows the money

00:47

from you You agreed alone the thousand dollars for one

00:51

year at fifteen percent annual interest That's the interest rate

00:55

written into the contract The nominal rate The loan has

00:58

to be paid back at the end of the year

00:59

Well meanwhile the inflation rate this year totals five percent

01:03

Prices on everything They're going up up up by an

01:05

average of five percent during those twelve months when the

01:08

money was borrowed So you alone the grand on January

01:10

one and buy the next December thirty one while you

01:13

get eleven fifty back That's fifteen percent nominal interest However

01:18

inflation has eaten into some of that profit for you

01:21

At least rent on your money every January you like

01:24

to buy a set of dinosaur shaped novelty T infuser

01:27

Sze to give away his New Year's gifts last January

01:30

you could buy a hundred tea infusions for thousand dollars

01:33

this New year's those same hundred T infuser is cost

01:36

a thousand fifty right The five percent inflation is at

01:39

work when you loaned the money out Well eleven hundred

01:42

fifty dollars could buy you one hundred fifteen t infuser

01:47

by the time you get the money back While eleven

01:49

fifty will only buy you about one hundred ten tion

01:51

fuse er's and you'll have to throw in about five

01:54

dollars of extra money to get the one hundred tenth

01:56

one of the math They're well Your money buys last

01:59

because of inflation The real interest rate takes into account

02:01

what you can buy with the money Write it subtracts

02:04

inflation from your rate of return So here is the

02:06

back of the envelope Way to calculate the rial interest

02:08

rate Take the nominal rate and subtract the rate of

02:11

inflation Yep that's it Bingo What's left over is the

02:14

real rate Very fancy The answer you get when you

02:16

do this calculation is approximate but it's an easy way

02:19

to get close See alone out the thousand dollars of

02:21

fifteen percent interest but inflation that years five percent So

02:24

fifteen minus five is ten in the rial interest rate

02:27

here Yes it's ten percent Well that checks out if

02:30

you don't count money as money but counted as what

02:32

you can buy with the money like T infuse er's

02:35

Last January one you loaned out enough money to buy

02:38

one hundred T infuser a thousand dollars back one An

02:40

infuser cost ten bucks each Now it's December thirty one

02:44

In the same year you got back enough money to

02:46

buy approximately one hundred ten T infuser Right You got

02:49

eleven fifty back but infuser is cost ten fifty each

02:52

Now Right five percent inflation One hundred fuses worth of

02:55

money last year turned into enough to buy one hundred

02:57

ten in futures this year one hundred to one hundred

02:59

ten That's ah ten percent net riel return That's the

03:03

rial interest rate When you're the lender inflation eats into

03:06

your profit What should be a fifteen percent return then

03:10

becomes a realty ten percent return because five percent of

03:13

our money got slurped up by higher prices On the

03:16

other hand well it can be helpful in the same

03:18

deal your friend is paying you back in currency That's

03:21

five percent easier to get arm or liquid When you're

03:23

a borrower inflation helps you pay off alone easier It's

03:27

why a lot of countries who are highly in debt

03:29

love having inflation because it makes their debt so much

03:32

easier to pay back That's why lenders have to keep

03:34

the inflation rate in mind when they're quoting raids for

03:37

what they'll lend money at So let's look at it

03:40

on a national scale Greece is in trouble yet again

03:43

The country needs like eighteen billion dollars in loans from

03:46

the World Bank just so it can afford the marbled

03:48

cleaning bill for the Parthenon The World Bank has to

03:51

decide what interest rate to charge Well inflation's been running

03:54

high lately Last year was eight percent Experts predict it

03:57

will be about that same level for the foreseeable Yes

04:00

we're totally making up these numbers with the real world

04:03

way lower than that Meanwhile the World Bank wants to

04:05

secure a really interest rate of five percent Well what

04:08

does it do Well it wants a five percent real

04:10

rate when inflation's aid so it has to set the

04:12

nominal rate that's going to charge Greece to about thirteen

04:15

percent That's by plus eight equals thirteen even in Greece

04:18

So what about inflation Correction Well inflation correction is the

04:21

process of taking inflation out of an equation You adjust

04:25

a figure to take inflation into account It's the process

04:28

you're using to determine the rial rate Will the nominal

04:31

rates thirteen percent inflations eight percent after correcting or adjusting

04:35

for inflation while you end up with a real rate

04:37

Then of yes five percent Grease takes its loan with

04:40

thirteen percent interest Now it can keep the Parthenon sparkling

04:44

clean and tracked all those tourists who keep it out

04:46

of bankruptcy And hopefully it'll bring in enough dough to

04:49

fix the Olympic Stadium next year Good luck with that 00:04:52.71 --> [endTime] grease

Full Transcript