Nominal Interest Rate

A Nominal Interest Rate is an interest rate which includes systematic, regulatory and inflation risks.

• Context:
  • It can be estimated as a sum between real interest rate and inflation rate (when the inflation rate is low).
  • …
• Counter-Example(s)
  • Real Interest Rate
  • Effective Interest Rate.
• See: Loan, Interest Rate, Inflation, Tax.

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References

2016

• (Wikipedia, 2016) ⇒ http://en.wikipedia.org/wiki/Nominal_interest_rate
  • In finance and economics, nominal interest rate or nominal rate of interest refers to two distinct things:

1. the rate of interest after adjustment for inflation (in contrast with the real interest rate); or,
2. for interest rates "as stated" without adjustment for the full effect of compounding (also referred to as the nominal annual rate). An interest rate is called nominal if the frequency of compounding (e.g. a month) is not identical to the basic time unit (normally a year). [...] The concept of real interest rate is useful to account for the impact of inflation. In the case of a loan, it is this real interest that the lender effectively receives. For example, if the lender is receiving 8 percent from a loan and the inflation rate is also 8 percent, then the (effective) real rate of interest is zero: despite the increased nominal amount of currency received, the lender would have no monetary value benefit from such a loan because each unit of currency would get devaluated due to inflation by the same factor as the nominal amount gets increased.

   The relationship between the real interest value [math]\displaystyle{ r }[/math], the nominal interest rate value [math]\displaystyle{ R }[/math], and the inflation rate value [math]\displaystyle{ i }[/math] is given by

[math]\displaystyle{ (1+r)=(1+R)/(1+i) \, }[/math]

• When the inflation rate [math]\displaystyle{ i }[/math] is low, the real interest rate is approximately given by the nominal interest rate minus the inflation rate, i.e.,

[math]\displaystyle{ r \approx R - i \, }[/math]

In this analysis, the nominal rate is the stated rate, and the real interest rate is the interest after the expected losses due to inflation. Since the future inflation rate can only be estimated, the ex ante and ex post (before and after the fact) real interest rates may be different; the premium paid to actual inflation may be higher or lower. In contrast, the nominal interest rate is always known in advance.

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