Define real interest rate.

The real interest rate is the interest rate that has been adjusted for inflation, reflecting the true cost of borrowing and the true yield of savings. It provides a more accurate measure of the purchasing power of money over time. When inflation rises, the value of money decreases, so adjusting for inflation allows consumers and investors to see the actual increase in their purchasing power or the actual cost of loans.

In contrast, the nominal interest rate is simply the stated interest rate without adjustments for inflation, potentially leading to a misleading perception of the cost of borrowing or the benefits of saving. The average rate of return on investments relates to expected gains from investments and does not specifically pertain to the relationship between borrowing costs and inflation. The rate set by the central bank refers more to monetary policy and the setting of short-term interest rates rather than a specific measure of adjusting interest rates for inflation.