The Difference Between Real Interest And Nominal Interest

February 7th, 2009 Comments off
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Like the earlier article on nominal and real income, we also need to understand the term Real Interest and Nominal Interest

Nominal Rate:

  • Official rate quoted by banks and financial institutions BEFORE accounting for the effect of inflation

Real Interest:

  • Interest rate AFTER accounting for the effect of inflation

Impact:

  • To savers, it he keeps his money with a bank at 5% nominal rate of interest but the level of inflation is 10%, the saver will lose by 5% real interest although the nominal rate of interest is 5%
  • To the bankers/financial institutions, when giving out loan to their customers, they need to ensure that their nominal rate of interest should be higher than the real rate of interest otherwise they will “lose” money. For example, if the bank’s nominal rate of interest for loan is 5% while the rate of inflation is 7%, the real rate of interest would be a negative (2%) that actually the bank will earn.

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