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Strategies & Market Trends : US Economic Trend Analysis
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From: gpowell4/11/2007 12:16:48 PM
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A while back CalculatedRisk ( Member 3925056 ) used the formula: Nominal Rates = Real Rates + CPI to try to show that real rates were as high today as in 1973. And although he issued a caveat that “it” was slightly more complicated than that, it also became clear that he didn’t really know much about that complication.

Let’s look at the actual Fisher Equation (rather than Calculatedrisk's approximation): Nominal = Real + I + Real x I. Where I represents inflation expectations and the rates of interest are risk free rates.

Now the problem is that calculatedrisk only considered ex-post real rates calculated from various measure of current inflation (CPI like measures). Using that methodology he determined that the inflation rate must have been zero over the most recent period. I see similar calculations being made all over SI. They are all mistaken and, further, it is completely unnecessary to calculate ex-post real rates. Interest rates are essentially a residual that results as economic agents actively engage their plans for the future. It really is immaterial how those plans may have been mistaken – and that is the only thing an ex-post real rate measures, i.e. past mistakes.

Well have more to say about this in a later post, as it relates directly to the current and future path of home prices.
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