REAL VS.

NOMINAL INTEREST RATE

REAL INTEREST RATE VS. NOMINAL INTEREST RATE

The term “interest rate” is one of the

most commonly used phrases in day to
day finance. Today we will cover - Real
vs. Nominal Interest Rates.
 CURRENT
REAL INTEREST RATEACCOUNT DEFICIT
VS. NOMINAL INTEREST RATE
Let us see the formula of the Current Account Balance (CAB)

CAB = X - M + NI + NCT
X = Exports of goods and services
M = Imports of goods and services
NI = Net income abroad [Salaries paid or received,
credit / debit of income from
FII & FDI etc. ]
NCT = Net current transfers [Workers' Remittances
(unilateral),
The difference Donations,
between nominal and
Aids & Grants,
real interest rate is theOfficial,
key economic
Assistance and Pensions etc]
factor – ‘Inflation’.
REAL INTEREST RATE VS. NOMINAL INTEREST RATE
Inflation is a rise in the general price
level. For instance, a 6% inflation rate
means that an average basket of goods
you purchased this year is 6% more
expensive as compared to last year.
 REAL INTEREST RATE VS. NOMINAL INTEREST RATE

Real Interest Rate is one where the effects of inflation have been factored
in.

Nominal Interest Rate is one where the effects of inflation have not been
accounted for.
REAL INTEREST RATE VS. NOMINAL INTEREST RATE

Let us consider an example to

illustrate the difference :
 REAL INTEREST RATE VS. NOMINAL INTEREST RATE

Suppose your fixed deposit of Rs. 100 earns 10% interest at the end of
the year.

This means the Rs. 100 at beginning of the year will become Rs. 110 at
the end of the year.

This 10% is the nominal interest rate, as we have not accounted for
inflation.
 CURRENT
REAL INTEREST RATEACCOUNT DEFICIT
VS. NOMINAL INTEREST RATE
Let us see the formula of the Current Account Balance (CAB)

CAB = X - M + NI + NCT
X = Exports of goods and services
M = Imports of goods and services
NI = Net income abroad [Salaries paid or received,
credit / debit of income from
FII & FDI etc. ]
[Workers'
NCT = Net current transfersWhenever Remittances
people speak of the
(unilateral), Donations,
interest rate they're talking about the
Aids & Grants, Official,
nominal interest rate, unless they
Assistance and Pensions etc]
state otherwise.
 REAL INTEREST RATE VS. NOMINAL INTEREST RATE

Assume that inflation rate is 6% for the year and your fixed deposit earns
10% nominal interest rate.

After factoring in inflation, your deposit will earn a real interest rate of 4%.
REAL INTEREST RATE VS. NOMINAL INTEREST RATE

COMPARING REAL & NOMINAL INTEREST RATE

Inflation = 6%
Nominal
Interest Rate
= 10%

Real Interest Rate = 4%

 CURRENT
REAL INTEREST RATEACCOUNT DEFICIT
VS. NOMINAL INTEREST RATE
Let us see the formula of the Current Account Balance (CAB)

CAB = X - M + NI + NCT
X = Exports of goods and services
M = Imports of goods and services
NI = Net income abroad [Salaries paid or received,
credit / debit of income from
FII & FDI
The relationship etc. ] nominal
between
[Workers'
NCT = Net current transfersinterest rate, Remittances
inflation, and real
interest rate(unilateral),
is describedDonations,
by the
Aids & Grants, Official,
Fisher Equation:
Assistance and Pensions etc]
Real Interest Rate = Nominal Interest Rate – Inflation
 REAL INTEREST RATE VS. NOMINAL INTEREST RATE

If inflation is positive, then the real interest rate is lower than the nominal
interest rate.

If we have deflation and the inflation rate is negative, then the real interest
rate will be larger.
 CURRENT
REAL INTEREST RATEACCOUNT DEFICIT
VS. NOMINAL INTEREST RATE
Let us see the formula of the Current Account Balance (CAB)

CAB = X - M + NI + NCT
X = Exports of goods and services
M = Imports of goods and services
NI = Net income abroad [Salaries paid or received,
credit / debit of income from
FII & FDI etc. ]
NCT = Net current transfers [Workers' Remittances

Hope you (unilateral), Donations,

have understood the
Aids & difference Grants,
betweenOfficial,
Real and
Assistance and Pensions etc]
Nominal Interest Rate.
 Please give us

your feedback at

professor@[Link]
 DISCLAIMER
The views expressed in this lesson are for information purposes only and do not construe to be
any investment, legal or taxation advice. The lesson is a conceptual representation and may not
include several nuances that are associated and vital. The purpose of this lesson is to clarify the
basics of the concept so that readers at large can relate and thereby take more interest in the
product / concept. In a nutshell, Professor Simply Simple lessons should be seen from the
perspective of it being a primer on financial concepts. The contents are topical in nature and
held true at the time of creation of the lesson. This is not indicative of future market trends, nor
is Tata Asset Management Ltd. attempting to predict the same. Reprinting any part of this
material will be at your own risk. Tata Asset Management Ltd. will not be liable for the
consequences of such action.

Mutual Fund investments are subject to market risks, read all

scheme related documents carefully.