<P> Charging interest equal to inflation preserves the lender's purchasing power, but does not compensate for the time value of money in real terms . The lender may prefer to invest in another product rather than consume . The return they might obtain from competing investments is a factor in determining the interest rate they demand . </P> <P> Since the lender is deferring consumption, they will wish, as a bare minimum, to recover enough to pay the increased cost of goods due to inflation . Because future inflation is unknown, there are three ways this might be achieved: </P> <Ul> <Li> Charge X% interest "plus inflation" Many governments issue "real - return" or "inflation indexed" bonds . The principal amount or the interest payments are continually increased by the rate of inflation . See the discussion at real interest rate . </Li> <Li> Decide on the "expected" inflation rate . This still leaves the lender exposed to the risk of "unexpected" inflation . </Li> <Li> Allow the interest rate to be periodically changed . While a "fixed interest rate" remains the same throughout the life of the debt, "variable" or "floating" rates can be reset . There are derivative products that allow for hedging and swaps between the two . </Li> </Ul> <Li> Charge X% interest "plus inflation" Many governments issue "real - return" or "inflation indexed" bonds . The principal amount or the interest payments are continually increased by the rate of inflation . See the discussion at real interest rate . </Li>

When do you use simple interest in real life