<p>There are practical problems with having 'real loan' even though theoretically they would actually be desirable (as paper <a href="https://www.econstor.eu/bitstream/10419/76905/1/wp055b.pdf" rel="nofollow noreferrer">&quot;The Impact of Inflation on Long-Term Housing Loans&quot; by Tschach, Ingo E.</a>) if they would be practical.</p>
<ol>
<li>We do not know what the current inflation is.</li>
</ol>
<p>This statement is simply incorrect:</p>
<blockquote>
<p>Of course we will need to know the current inflation rate, but it's not like this information is secret, so it shouldn't be a problem.</p>
</blockquote>
<p>When you look at inflation statistics they do not report actual inflation, they report the estimation of what the inflation is. The inflation estimation is based on a basket of goods that is considered representative and most statistical offices try their best to appropriately capture inflation but it is still just the best estimate and it is generally agreed that all inflation measures have some non-trivial flaws. They for example often do not appropriately capture changes in quality of goods due to technology and it is also highly questionable how different items should be weighted. Those two issues are just an examples there are many more, you can have a look at <a href="https://www.investopedia.com/ask/answers/012915/what-are-some-limitations-consumer-price-index-cpi.asp" rel="nofollow noreferrer">this investopedia</a> article that explores the main issues in measuring inflation (but not all).</p>
<p>This issue could be circumvented by bank and client agreeing that some inflation measure such as CPI would be considered the inflation but that would cause some serious trouble down the road. For example, what if statistical office decides to update its CPI measure in a way to benefit borrowers or vice versa? The way we measure inflation evolves over time and thus using some real loan based on an ever evolving measure instead of actual inflation would not eliminate inflation related risk completely.</p>
<ol start="2">
<li>Inflation is rarely reported in real time.</li>
</ol>
<p>Even the best statistical offices usually have about 3-1 month lag in measuring inflation and the most recent measurements of inflation can relatively often be revised later.</p>
<p>This creates another problem as it would make it very difficult to determine each month what the inflation is and hence what actually should be the interest rate paid. All loans would have to be paid with a lag that could even differ per country and due to the possibility of revisions banks would have to send out refunds or send out requests for customers to pay more as the revisions occur.</p>
<p>In future it might be possible to track inflation in real time. There is for example the <a href="http://www.thebillionpricesproject.com/" rel="nofollow noreferrer">billion prices project</a> that attempts to do so. However, measuring inflation in real time is still in its infancy and the projects also has its own additional problem of being biased toward goods that are sold by e-commerce and it does not solve the problems in 1.</p>
<ol start="3">
<li>Even though you are correct in saying:</li>
</ol>
<blockquote>
<p>Borrowers and lenders would know that neither of them would benefit from inflation/deflation at cost of the other side, so borrowers would be more willing to borrow and lenders would be more willing to lend</p>
</blockquote>
<p>this is basically what the authors of the paper linked above show in their simulations. You are not correct in stating that this would make the loan more predictable. It eliminates the inflation risk of the loan but as Giskard points out you are paid in nominal terms not real terms so the real value you need to transfer back to the bank is not more predictable per se.</p>

CC BY-SA 4.0
2020-07-30T13:43:57.217Z
"even though theoretically they would actually be desirable" Considering that real loans wouldn't be more predictable - why? (asked on behalf of users who may have problems with downloading the paper in the future)
KarmaPeasant
CC BY-SA 4.0
2020-07-30T13:45:40.807Z
@user161005 I will quote from their conclusion: "Traditionally, repayment plans are based on nominal interest rates. If we plot the curve
of the resultant outstanding balances or installment payments over time in real terms,
i.e. adjusted for inflation, we can observe that inflation reduces the borrowing capacity
of customers because they have to pay absurdly high repayment installments during the
early years. If the inflation rate rises after a loan agreement has been concluded, and
therefore – assuming that variable interest rates have been agreed – the nominal
1muflon1
CC BY-SA 4.0
2020-07-30T13:46:41.127Z
interest
rate also rises, both the bank and the customers incur a disproportionately high risk of
default. As a consequence, banks have to be extremely cautious when issuing long-term
loans in order to avoid excessively high risks. Thus, inflation, or even the mere
uncertainty caused by expectations of inflation, has a strongly adverse impact on longterm lending. These adverse effects can be avoided if long-term loans are issued “in real terms”.
1muflon1
CC BY-SA 4.0
2020-07-30T13:47:01.610Z
According to this system, the size of the installments due are calculated on the basis of
the real interest rate and are adjusted for inflation throughout the life of the loan. This
can mean that the nominal value of the outstanding balance increases during the first
years; however, in real terms, the loan is repaid as if there were no inflation and the
interest rate would correspond to the real interest rate.
1muflon1
CC BY-SA 4.0
2020-07-30T13:47:49.220Z
Compared with traditional
lending methods, this not only increases the borrowing capacity of the clients, i.e. the
maximum amount that they can afford to borrow given a certain payment capacity, but
also the probability that the borrowers will continue to be able to pay their installments
even if inflation rates go up. A precondition for the successful application of this new concept is that charging
compound interest is legally permissible.
1muflon1
CC BY-SA 4.0
2020-07-30T13:47:57.247Z
As explained above, the nominal outstanding
balance can substantially exceed the original nominal loan amount. If banks were not
allowed to charge compound interest, it would not be economic for them to use the new
method because they would not earn any interest on a part of their outstanding loans. "
1muflon1
CC BY-SA 4.0
2020-07-30T13:03:12.453Z
2020-07-30T17:57:15.177Z
2020-07-30T17:57:15.177Z
1muflon1
<p>As far as I understand, all/majority of loan contracts charge nominal interest rate, there are (almost?) no loan contracts that charge fixed real interest rate. Why is it so? Normally I would expect the directly opposite situation, with all (or the vast majority of) loan contracts charging the fixed real interest rate. After all, such loans would be more predictable compared to charging nominal interest rate. Borrowers and lenders would know that neither of them would benefit from inflation/deflation at cost of the other side, so borrowers would be more willing to borrow and lenders would be more willing to lend, real interest rate paid would be the same no matter what happens with the aggregate price level. Of course we will need to know the current inflation rate, but it's not like this information is secret, so it shouldn't be a problem.</p>

CC BY-SA 4.0
2020-07-30T12:47:30.493Z
"*such loans would be more predictable*" Are you payed in real goods by your employer, not (nominal) money?
Giskard
CC BY-SA 4.0
2020-07-30T13:03:35.833Z
@Giskard I don't think it's a fair comparison. Being payed in goods would eliminate choice that I have in choosing goods that I want to consume. It would also eliminate possibility of making savings. But given that I'm fine with both of these limitation such "wage" would indeed more predictable than nominal money wage
KarmaPeasant
<macroeconomics><inflation><interest-rate><banking>
Why do all/majority of loan contracts charge nominal interest rate instead of fixed real interest rate?
KarmaPeasant
# Why do all/majority of loan contracts charge nominal interest rate instead of fixed real interest rate?

(Asked by: username_0 on 2020-07-30)

As far as I understand, all/majority of loan contracts charge nominal interest rate, there are (almost?) no loan contracts that charge fixed real interest rate. Why is it so? Normally I would expect the directly opposite situation, with all (or the vast majority of) loan contracts charging the fixed real interest rate. After all, such loans would be more predictable compared to charging nominal interest rate. Borrowers and lenders would know that neither of them would benefit from inflation/deflation at cost of the other side, so borrowers would be more willing to borrow and lenders would be more willing to lend, real interest rate paid would be the same no matter what happens with the aggregate price level. Of course we will need to know the current inflation rate, but it's not like this information is secret, so it shouldn't be a problem.

**Tags:** macroeconomics, inflation, interest-rate, banking

> **Comments:**
> **username_1**: "*such loans would be more predictable*" Are you payed in real goods by your employer, not (nominal) money?  
> **username_0**: @username_1 I don't think it's a fair comparison. Being payed in goods would eliminate choice that I have in choosing goods that I want to consume. It would also eliminate possibility of making savings. But given that I'm fine with both of these limitation such "wage" would indeed more predictable than nominal money wage  

---

## 1 answers

### Answer by username_2 on 2020-07-30. Score: 2

There are practical problems with having 'real loan' even though theoretically they would actually be desirable (as paper ["The Impact of Inflation on Long-Term Housing Loans" by Tschach, Ingo E.](https://www.econstor.eu/bitstream/10419/76905/1/wp055b.pdf)) if they would be practical.

1. We do not know what the current inflation is.

This statement is simply incorrect:

> Of course we will need to know the current inflation rate, but it's not like this information is secret, so it shouldn't be a problem.

When you look at inflation statistics they do not report actual inflation, they report the estimation of what the inflation is. The inflation estimation is based on a basket of goods that is considered representative and most statistical offices try their best to appropriately capture inflation but it is still just the best estimate and it is generally agreed that all inflation measures have some non-trivial flaws. They for example often do not appropriately capture changes in quality of goods due to technology and it is also highly questionable how different items should be weighted. Those two issues are just an examples there are many more, you can have a look at [this investopedia](https://www.investopedia.com/ask/answers/012915/what-are-some-limitations-consumer-price-index-cpi.asp) article that explores the main issues in measuring inflation (but not all).

This issue could be circumvented by bank and client agreeing that some inflation measure such as CPI would be considered the inflation but that would cause some serious trouble down the road. For example, what if statistical office decides to update its CPI measure in a way to benefit borrowers or vice versa? The way we measure inflation evolves over time and thus using some real loan based on an ever evolving measure instead of actual inflation would not eliminate inflation related risk completely.

2. Inflation is rarely reported in real time.

Even the best statistical offices usually have about 3-1 month lag in measuring inflation and the most recent measurements of inflation can relatively often be revised later.

This creates another problem as it would make it very difficult to determine each month what the inflation is and hence what actually should be the interest rate paid. All loans would have to be paid with a lag that could even differ per country and due to the possibility of revisions banks would have to send out refunds or send out requests for customers to pay more as the revisions occur.

In future it might be possible to track inflation in real time. There is for example the [billion prices project](http://www.thebillionpricesproject.com/) that attempts to do so. However, measuring inflation in real time is still in its infancy and the projects also has its own additional problem of being biased toward goods that are sold by e-commerce and it does not solve the problems in 1.

3. Even though you are correct in saying:

> Borrowers and lenders would know that neither of them would benefit from inflation/deflation at cost of the other side, so borrowers would be more willing to borrow and lenders would be more willing to lend

this is basically what the authors of the paper linked above show in their simulations. You are not correct in stating that this would make the loan more predictable. It eliminates the inflation risk of the loan but as username_1 points out you are paid in nominal terms not real terms so the real value you need to transfer back to the bank is not more predictable per se.

> **Comments:**
> **username_0**: "even though theoretically they would actually be desirable" Considering that real loans wouldn't be more predictable - why? (asked on behalf of users who may have problems with downloading the paper in the future)  
> **username_2**: @user161005 I will quote from their conclusion: "Traditionally, repayment plans are based on nominal interest rates. If we plot the curve of the resultant outstanding balances or installment payments over time in real terms, i.e. adjusted for inflation, we can observe that inflation reduces the borrowing capacity of customers because they have to pay absurdly high repayment installments during the early years. If the inflation rate rises after a loan agreement has been concluded, and therefore – assuming that variable interest rates have been agreed – the nominal  
> **username_2**: interest rate also rises, both the bank and the customers incur a disproportionately high risk of default. As a consequence, banks have to be extremely cautious when issuing long-term loans in order to avoid excessively high risks. Thus, inflation, or even the mere uncertainty caused by expectations of inflation, has a strongly adverse impact on longterm lending. These adverse effects can be avoided if long-term loans are issued “in real terms”.  
> **username_2**: According to this system, the size of the installments due are calculated on the basis of the real interest rate and are adjusted for inflation throughout the life of the loan. This can mean that the nominal value of the outstanding balance increases during the first years; however, in real terms, the loan is repaid as if there were no inflation and the interest rate would correspond to the real interest rate.  
> **username_2**: Compared with traditional lending methods, this not only increases the borrowing capacity of the clients, i.e. the maximum amount that they can afford to borrow given a certain payment capacity, but also the probability that the borrowers will continue to be able to pay their installments even if inflation rates go up. A precondition for the successful application of this new concept is that charging compound interest is legally permissible.  
> **username_2**: As explained above, the nominal outstanding balance can substantially exceed the original nominal loan amount. If banks were not allowed to charge compound interest, it would not be economic for them to use the new method because they would not earn any interest on a part of their outstanding loans. "  

---

