FAQ on Nominal and Real Interest Rates
Q1. What is the difference between Nominal and Real Interest Rates?
Ans. Nominal interest rates are the stated interest rates in a loan or deposit agreement, while real interest rates are the nominal interest rates adjusted for inflation. Real interest rates reflect the true cost of borrowing or the true return on a deposit, taking into account the changes in the purchasing power of money over time.
Q2. Why is it Important to consider both Nominal and Real Interest Rates?
Ans. It is essential to consider both nominal and real interest rates when making financial decisions because they can have different impacts on the cost of borrowing and the return on a deposit. The nominal interest rate determines the interest payments on a loan or the interest earned on a deposit. In contrast, the real interest rate reflects the true cost of borrowing or the true return on a deposit, considering the impact of inflation.
Q3. Can Nominal Interest Rates be Higher or Lower than Real Interest Rates?
Ans. Yes, nominal interest rates can be either higher or lower than real interest rates depending on the inflation rate. When the inflation rate is positive, nominal interest rates are often higher than real interest rates. Conversely, when the inflation rate is negative, nominal interest rates are often lower than real interest rates.
Q4. How is the Real Interest Rate Calculated?
Ans. The real interest rate is calculated using the following formula: Real interest rate = Nominal interest rate – Inflation rate
Nominal vs Real Interest Rates
The portion of a loan that is charged to the borrower is called an interest rate, and it is often stated as an annual percentage. Lenders utilize interest rates to cover the risk they assume when making loans, and they can also be used to help keep inflation under control.
Contact Us