Sunday, October 5, 2008

The Difference Between Nominal and Real Variables is the Inflation Rate

The Difference Between Nominal and Real Variables

The difference between nominal and real variables is the inflation rate. For example, the difference between the nominal interest rate and the real interest rate is the inflation rate. The nominal interest rate is the stated rate of return on a financial asset, such as the interest rate a bank pays on a certificate of deposit. The real interest rate is the nominal rate of return adjusted for inflation.

real interest rate = nominal interest rate - inflation rate

nominal interest rate = real interest rate + inflation rate

inflation rate = nominal interest rate - real interest rate


Table 2 provides examples of the relationship between the nominal interest rate, the real interest rate, and the inflation rate. The real interest rate is kept constant at 1%. This reflects the rate of return on a financial asset with low risk, such as a certificate of deposit.

nominal interest rate
real interest rate
inflation rate
1%
1%
0%
2%
1%
1%
3%
1%
2%
4%
1%
3%
5%
1%
4%
6%
1%
5%
7%
1%
6%
8%
1%
7%
9%
1%
8%
10%
1%
9%
11%
1%
10%
12%
1%
11%
...
...
...
51%
1%
50%
Table 2. The difference between nominal variables and real variables is the inflation rate.

1 comment:

  1. could you please sort few macro variables as nominal and real???

    ReplyDelete