Inflation Rate Vs. Interest Rate

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The inflation rate and interest rates have a profound impact on how the economy works. Understanding how they interact can help you manage and invest your money better.

Inflation Rate

  • The inflation rate is the rate at which prices are increasing in the economy. This is often measured by observing changes in the price of a set bundle of common consumer goods, known as the consumer price index (CPI).

Interest Rates

  • Interest rates are the rates that people or organizations pay to use the money of other people or groups -- essentially the price of borrowing money.

Risk

  • Risk plays a large role in determining interest rates. Lenders will give you a lower rate if they believe you are more likely to pay them back. Credit scores are a means for lenders to determine the risk of lending to a certain borrower.

Real Interest Rates

  • Real interest rates are calculated by subtracting the inflation rate from a nominal interest rate, such as the rate paid on a savings account. Real interest rates are the net gain of interest charged on borrowed money, taking the inflation rate into account.

Deflation

  • It is possible for the inflation rate to be negative, which is called deflation, meaning that prices are falling throughout the economy.

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