Lesson summary: nominal vs. real interest rates
|nominal interest rate||the interest rate that you earn (or pay) on a loan; this is the amount you see on a sign advertising interest rates.|
|real interest rate||the nominal interest rate adjusted for inflation; this is the effective interest rate that you earn (or pay).|
|Fisher effect||the idea that an increase in expected inflation drives up the nominal interest rate, which leaves the expected real interest rate unchanged|
Nominal interest is the sum of the expected real interest rate and the expected inflation rate
The interest rate borrowers pay and savers earn
The real interest rate in retrospect
- A point of confusion some people have is whether nominal and real interest rates can be negative. Real interest rates can be negative, but nominal interest rates cannot. Real interest rates are negative when the rate of inflation is higher than the nominal interest rate. Nominal interest rates cannot be negative because if banks charged a negative nominal interest rate, they would be paying you to borrow money! This is called the “zero bound” on interest rates: the nominal interest rate can only go down to .
- Tywin knows he has a debt to repay soon. The bank charges him an interest rate of . If the expected rate of inflation is , how much interest is he effectively paying? Explain.
- Calculate the nominal rate of inflation that will be charged if the expected rate of inflation is and the real return desired is . Show all work.
- The real interest rate paid on an asset was , but the nominal rate was . What was the rate of inflation?