π‘οΈmacroeconomics
Nominal vs Real Interest Rate
Nominal Rate vs Real Rate
The nominal rate includes inflation. The real rate strips it out to show true purchasing power growth.
Comparison Table
| Feature | Nominal Rate | Real Rate |
|---|---|---|
| Includes inflation? | Yes | No |
| Formula (Fisher) | (1+r_real)(1+Ο) = (1+r_nominal) | r_real β r_nominal - Ο |
| What it measures | Total stated return | Purchasing power return |
| Used for | Bond yields, loan rates | Real economic analysis, TIPS |
Key Differences
- βNominal is what you see quoted; real is what you actually earn after inflation
- βFisher equation links the two precisely
- βThe approximation (nominal - inflation) works for low rates
When to Use Nominal Rate
- βQuoting interest rates
- βDiscounting nominal cash flows
- βMost standard finance problems
When to Use Real Rate
- βComparing returns across countries with different inflation
- βDiscounting real (inflation-adjusted) cash flows
- βLong-term purchasing power analysis
Common Confusions
- !Mixing nominal cash flows with real discount rates
- !Using the approximation when rates are high (use exact Fisher equation)
FAQs
Common questions about this comparison
Approximately 5%. Exactly: (1.08/1.03) - 1 = 4.85%.