4.2 Nominal v. Real Interest Rates
The real interest rate is the nominal rate minus expected inflation (Fisher equation), it measures gained purchasing power, not just dollars.
The nominal interest rate is the stated rate on a loan or deposit; the real interest rate adjusts it for inflation. The Fisher equation ties them together: real rate ≈ nominal rate − expected inflation, or equivalently nominal rate ≈ real rate + expected inflation.
Distinguish expected from actual inflation. Borrowers and lenders agree to a nominal rate based on EXPECTED inflation; the realized real rate depends on ACTUAL inflation. When inflation comes in higher than expected, borrowers win, they repay in cheaper dollars, and lenders lose. Lower-than-expected inflation reverses the transfer.
Watch the graph link too: the loanable funds market (Topic 4.7) is drawn with the REAL interest rate, while the money market (Topic 4.5) uses the NOMINAL rate. Many multiple-choice points come from just knowing which rate belongs where.
Key terms for 4.2
Practice the math
Flipping the Fisher equation, the real rate is nominal MINUS expected inflation. If a bank charges 6% and expected inflation is 4%, the lender's expected real return is only 2%.
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