Nominal v. Real Interest Rates
Introduced| English | Meaning |
|---|---|
| real interest rate/rɪəl ˈɪntrest reɪt/ | An interest rate adjusted for inflation, approximately the nominal rate minus the inflation rate when rates are small. |
| Fisher equation/ˈfɪʃə ɪˈkweɪʒn/ | The relationship linking nominal interest, real interest and inflation; approximately, the nominal rate equals the real rate plus expected inflation for an ex-ante calculation. |
| nominal interest rate/ˈnɒmɪnl ˈɪntrest reɪt/ | The percentage a lender charges in current dollars. |
| expected inflation/ekˈspektɪd ɪnˈfleɪʃn/ | The increase in the general price level that people anticipate over a specified future period. |
| borrowers/ˈbɒrəʊəz/ | People or institutions that receive funds with an obligation to repay them. |
| lenders/ˈlendəz/ | People or institutions that provide funds to borrowers with an agreement for repayment. |
The interest rate that really matters
- The rate you see quoted is in current dollars — but inflation eats those dollars.
- So the number on the loan is not the whole story.
- What matters is how much buying power a lender truly earns.
- That is the difference between the nominal and the real interest rate.
The Fisher equation
- The nominal interest rate 名义利率 is the percentage a lender charges in current dollars.
- The real interest rate 实际利率 strips inflation out.
- The Fisher equation 费雪方程: $\text{real rate} \approx \text{nominal rate} - \text{expected inflation}$.
- Expected inflation 预期通货膨胀 is how much prices are expected to rise.
Real interest rate = nominal interest rate − inflation rate
Higher inflation than expected — who wins?
The real rate is the nominal rate minus inflation. If inflation is higher than expected, borrowers win and lenders lose.
The Fisher equation says the real interest rate approximately equals:
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Real ≈ nominal − expected inflation — inflation is subtracted out.
The interest rate quoted in current dollars, before removing inflation, is the ______ rate.
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The nominal rate includes inflation; the real rate takes it out.
To know how much buying power a lender truly earns, you use the:
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The real rate strips out inflation, showing the true gain in purchasing power.
Who wins from surprise inflation
- The gap between expected and actual inflation decides who gains.
- If inflation is higher than expected, borrowers 借款人 win — they repay in cheaper dollars — and lenders 放款人 lose.
- If inflation is lower than expected, lenders win and borrowers lose.
A loan has a nominal rate of 6% and inflation turns out to be 5%. What is the real interest rate, in percent?
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Real rate = 6 − 5 = 1%.
If inflation turns out higher than expected:
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Borrowers repay with cheaper dollars, so lenders receive less buying power.
If inflation is lower than expected, borrowers gain and lenders lose.
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False. The dollars repaid buy more than the lender planned, so lenders gain and borrowers lose when inflation is lower than expected.
A worked case
- Worked idea. A bank lends at a nominal rate of 6% and expects 2% inflation, so it plans on a real return of $6 - 2 = 4\%$.
- If inflation instead jumps to 5%, the real rate it actually earns is only $6 - 5 = 1\%$.
- The borrower repaid with cheaper dollars, so the borrower gained and the bank lost.
- This is exactly why unexpected inflation redistributes wealth.
The nominal interest rate is quoted in current dollars; the real interest rate removes inflation, via the Fisher equation ($\text{real} \approx \text{nominal} - \text{expected inflation}$). Higher-than-expected inflation helps borrowers and hurts lenders; lower-than-expected does the reverse.
Write from a real rate of 5 percent
- The nominal interest rate is 9 percent. Inflation is 4 percent.
- Find the real rate.
A loan has a nominal interest rate of 9 percent and inflation is 4 percent. What is the real interest rate, in percent?
9 minus 4 is 5.
What is the real interest rate?
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9 percent minus inflation of 4 percent is a real rate of 5 percent.