Hi, would someone be able to explain the relationship between real rates, nominal rates, and inflation? I don’t understand why if inflation decreases, your real rate doesn’t change. Doesn’t your real purchasing power increase??
approx relationship is: nominal rate = real rate + expected inflation so, if inflation changes, nominal rate will change by the same amount… it has no effect on the real rate…
(1 + RFR(Nominal)) = (1 + RFR(Real)) * (1 + Expected inflation) so there is a direct relation…
think about it like any linear regression… say, k = Rf + Beta (Market return premium) a change in the market return premium, or in beta, will affect k… it will NOT affect Rf
First, Inflation is the rate of increase in prices 1. By inflation decrease, you would mean that the rate of increase in prices have decreased. Annual Inflation has decreased from 3% to 2% means that prices next year will increase by 2% instead of 3%. So, nominal values will still increase, only at a lesser rate. 2. If you are talking about deflation then thats negative inflation. Thats when nominal values will decrease - deflation. In my understanding, the salaries/wages should also adjust according to the inflation and nominal values, so that your real purchasing power remains the same. Someone please tell me if i am right