Price premium

Price premium is the reflection of anticipated future price changes contained in market interest rates. The component in gross market interest rates which attempts to allow for the anticipated changes in the purchasing power of money, i.e., prices. Because changes in the quantity of money usually precede their effects, the price premium tends to lag behind changes in purchasing power. The price premium is added to, or subtracted from, the originary rate of interest and is one reason for the spread between the originary and market interest rates.

The price premium is negative (a minus component) when it reflects an anticipated rise in the purchasing power of money, i.e., a drop in prices, and positive (a plus component) when it reflects an anticipated drop in the purchasing power of money, i.e., a rise in prices, as is frequently the case when inflation is anticipated.