A nominal interest rate is the interest rate rate quoted on lending and borrowing transactions. Nominal rates represent the rate of exchange between current and future dollars. It is unadjusted for the effects of inflation. Since nominal rates are not adjusted for inflation, they do not convey the prices of lending and borrowing transactions as accurately as real interest rates. In comparison, real interest rates are adjusted for inflation.
Nominal interest rates are not adjusted for inflation. Adjust real interest rates for inflation. Make the adjustment with current or projected inflation rates. Furthermore, real interest rates offer a more accurate representation of the prices of lending and borrowing transactions. Use the following formula to calculate real interest rates:
For example, if a lender offers a loan with a nominal rate of 5% and the inflation rate is 3%, then the lender will earn real interest of 2%. If, however, the inflation rate is 7%, then the lender will essentially be losing value on the loan.
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