Nominal Versus Real Interest Rate
The real interest rate is the nominal rate of interest minus inflation. In the case of a loan, it is this real interest that the lender receives as income. If the lender is receiving 8 percent from a loan and inflation is 8 percent, then the real rate of interest is zero because nominal interest and inflation are equal. A lender would have no net benefit from such a loan because inflation fully diminishes the value of the loan's profit.
The relationship between real and nominal interest rates can be described in the equation:
where r is the real interest rate, i is the inflation rate, and R is the nominal interest rate.
- A common approximation for the real interest rate is:
- real interest rate = nominal interest rate - expected inflation
In this analysis, the nominal rate is the stated rate, and the real interest rate is the interest after the expected losses due to inflation. Since the future inflation rate can only be estimated, the ex ante and ex post (before and after the fact) real interest rates may be different; the premium paid to actual inflation may be higher or lower. In contrast, the nominal interest rate is known in advance.
Read more about this topic: Nominal Interest Rate
Famous quotes containing the words nominal, real, interest and/or rate:
“Discourage litigation. Persuade your neighbors to compromise whenever you can. Point out to them how the nominal winner is often a real loser—in fees, expenses, and waste of time. As a peacemaker the lawyer has a superior opportunity of being a good man. There will still be business enough.”
—Abraham Lincoln (1809–1865)
“To the real artist in humanity, what are called bad manners are often the most picturesque and significant of all.”
—Walt Whitman (1819–1892)
“President Kennedy had a wholesome, widely discussed, and largely deserved reputation for his interest in women.... But no President, however young and energetic, could possibly have gotten around to all the ladies in Washington, New York, and Hollywood who made claim to his affections after he died.... Such was the force of Jack Kennedy and the manner of his death that anyone associated with him, even the pretenders, assumed added glamour and interest.”
—Barbara Howar (b. 1934)
“Unless a group of workers know their work is under surveillance, that they are being rated as fairly as human beings, with the fallibility that goes with human judgment, can rate them, and that at least an attempt is made to measure their worth to an organization in relative terms, they are likely to sink back on length of service as the sole reason for retention and promotion.”
—Mary Barnett Gilson (1877–?)