nominal interest rate. Real and nominal interest rate The nominal interest rate i is equal to

a) the interest rate established without taking into account the change in the purchasing value of money due to inflation (or the general interest rate, in which its inflationary component is not eliminated);

b) the interest rate on a fixed income security, which provides for its use in relation to the nominal value, and not to the market price of this security.

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Quite often you can see, at first glance, profitable offers that promise financial independence. These can be both bank deposits and opportunities for investment portfolios. But is everything as profitable as advertising says? We will talk about this in the framework of the article, having found out what the nominal rate and the real rate are.

Interest rate

But first, let's talk about the basis of the basics in this matter - the interest rate. It displays the nominal benefit that a certain person can receive when investing in something. It should be noted that there are quite a few opportunities to lose your savings or the interest rate that a person should receive:

Therefore, it is necessary to study in great detail what you are going to invest in. It should be remembered that the interest rate is often a reflection of the riskiness of the project under study. So, those that offer a yield level of up to 20% are considered the safest. The high-risk group includes assets that promise up to 70% per annum. And everything that is more than these indicators is a danger zone into which you should not meddle without experience. Now that there is a theoretical basis, we can talk about what the nominal rate and the real rate are.

The concept of the nominal rate

It is very simple to determine the nominal value - it is understood as the value that is given to market assets and evaluates them without inflation. An example is you, the reader, and a bank that offers a deposit at 20% per annum. For example, you have 100 thousand rubles and want to increase them. So they put it in the bank for one year. And at the end of the term they took 120 thousand rubles. Your net profit is as much as 20,000.

But is it really so? After all, during this time, food, clothing, travel could have risen in price significantly - and, say, not by 20, but by 30 or 50 percent. What to do in this case to get a real picture of things? What should be given preference when given the choice? What should be chosen as a benchmark for oneself: the nominal rate and the real rate, or one of them?

Real rate

For such cases, there is such an indicator as the real rate of return. It is noteworthy that it can be calculated quite easily. To do this, the expected inflation rate should be subtracted from the nominal rate. Continuing the example given earlier, we can say this: you put 100 thousand rubles in the bank at 20% per annum. Inflation was only 10%. As a result, the net nominal profit will be 10 thousand rubles. And if you adjust their cost, then 9,000 according to the purchasing power of last year.

This option allows you to get, albeit insignificant, but profit. Now we can consider another situation in which inflation was already 50 percent. You do not need to be a mathematical genius to understand that the state of affairs forces you to look for some other way to save and increase your funds. But all this has been in the style of a simple description so far. In economics, the so-called Fisher equation is used to calculate all this. Let's talk about him.

Fisher's equation and its interpretation

It is possible to talk about the difference between the nominal rate and the real rate only in cases of inflation or deflation. Let's look at why. For the first time, the idea of the relationship between nominal and real rates with inflation was put forward by economist Irving Fisher. In formula form, it looks like this:

NS=RS+OTI

HC is the nominal rate of return;

GTI - expected rate of inflation;

RS - real rate.

The equation is used to mathematically describe the Fisher effect. It sounds like this: the nominal interest rate always changes by the amount at which the real remains unchanged.

It may seem complicated, but now we will understand in more detail. The fact is that when the expected value is 1%, the nominal value also increases by 1%. Therefore, it is impossible to create a quality investment decision-making process without taking into account the difference between rates. Previously, you only read about the thesis, and now you have mathematical evidence that everything described above is not a simple fiction, but, alas, a sad reality.

Conclusion

And what can be said in conclusion? Whenever there is a choice, it is necessary to qualitatively approach the selection of an investment project for oneself. It does not matter what it is: a bank deposit, participation in a mutual investment fund, or something else. And to calculate future income or possible losses, always use economic tools. So, the nominal interest rate can promise you a pretty good profit now, but when evaluating all the parameters, it will turn out that not everything is so rosy. And economic tools will help to calculate which decision will be the most profitable.

It is customary to evaluate the interest rate in two projections: nominal and real values.

The nominal interest rate reflects the current position of the asset value. Its main difference from the real rate is its independence from market conditions. The nominal rate in monetary terms reflects the cost of capital, excluding inflationary processes. The real rate, in contrast to the nominal rate, demonstrates the value of the cost of financial resources, taking into account the value of inflation.

Based on the definition of this concept, it can be seen that the nominal interest rate does not take into account changes in price increases and other financial risks. The nominal rate can be taken into account by market participants only as an introductory value.

math effect

The dependence of nominal and real rates has received its mathematical reflection in the Fisher equation. This mathematical model looks like this:

Real rate + Expected inflation rate = Nominal rate

The Fisher effect is mathematically described as follows: The nominal rate changes by the amount at which the real rate remains unchanged.

It is the future rate of inflation that matters in the formation of the market rate, taking into account the maturity of the debt claim, and not the actual rate that was in the past.

Equality of the nominal rate and the real one is possible only in the complete absence of deflation or inflation. This state of affairs is practically unrealistic and is considered in science only in the form of ideal conditions for the functioning of the capital market.

Nominal compound interest rate

Most often, the nominal interest rate is applied when lending. This is due to the dynamic and competitive loan market. The determination of the cost of capital within credit lines is assessed based on the term of the loan, currency and legal features of the borrowing. Banks, trying to minimize their risks, prefer to lend to customers in long-term cooperation in foreign currency, and in short-term cooperation in domestic.

In order to correctly assess the expected income from the use of funds for a long period of time, economists advise taking into account the compound interest scheme. When accruing profit by the compound interest method, at the beginning of each new regulatory period, profit is accrued for the amount received at the end of the previous period.

Any market mechanism in a volatile environment, especially such as the domestic economy, is always associated with high risks. Whether it is a loan agreement or investment in securities, opening a new business or depository cooperation with a bank. Always evaluating the potential profit, it is necessary to pay attention to external factors and the real state of the market. Based only on the nominal yield, you can make the wrong, obviously unprofitable or even potentially disastrous financial decision.

The most important characteristic of the modern economy is the depreciation of investments through inflationary processes. This fact makes it expedient to use not only the nominal, but also the real interest rate when making certain decisions in the market. What is the interest rate? What does it depend on? How ?

The concept of the interest rate

The interest rate should be understood as the most important economic category, reflecting the profitability of any asset in real terms. It is important to note that it is the interest rate that plays a decisive role in the process of making managerial decisions, because any economic entity is very interested in obtaining the maximum level of revenue at minimum cost in the course of its activities. In addition, each entrepreneur, as a rule, reacts to the dynamics of the interest rate in an individual way, because in this case the determining factor is the type of activity and the industry in which, for example, the production of a particular company is concentrated.

Thus, owners of capital are often only willing to work if the interest rate is extremely high, and borrowers are only likely to buy capital if the interest rate is low. The above examples are clear evidence that today it is very difficult to find a balance in the capital market.

Interest rates and inflation

The most important characteristic of a market economy is the presence of inflation, which leads to the classification of interest rates (and, of course, the rate of return) into nominal and real. This allows you to fully evaluate the effectiveness of financial transactions. If the inflation rate exceeds the interest rate received by the investor on investments, the result of the corresponding operation will be negative. Of course, in terms of absolute value, his funds will increase significantly, that is, for example, he will have more money in rubles, but the purchasing power that is characteristic of them will fall significantly. This will lead to the opportunity to buy only a certain amount of goods (services) for the new amount, which is less than it would have been possible before the start of this operation.

Distinctive features of nominal and real rates

As it turned out, they differ only in terms of inflation or deflation. Under inflation should be understood as a significant and sharp and under deflation - their significant fall. Thus, the nominal rate is considered to be the rate assigned by the bank, and the purchasing power inherent in income and denoted as interest. In other words, the real interest rate can be defined as the nominal one, which is adjusted for the inflationary process.

Irving Fisher, an American economist, formed a hypothesis explaining how it depends on nominal. The main idea of the Fisher effect (this is how the hypothesis is called) is that the nominal interest rate tends to change in such a way that the real one remains “fixed”: r(n) = r(p) + i. The first indicator of this formula reflects the nominal interest rate, the second - the real interest rate, and the third element is equivalent to the expected rate of inflationary processes, expressed as a percentage.

The real interest rate is...

A striking example of the Fisher effect, discussed in the previous chapter, is the picture when the expected pace of the inflationary process is equal to one percent per annum. Then the nominal interest rate will also rise by one percent. But the real percentage will remain unchanged. This proves that the real interest rate is the same as the nominal interest rate minus the assumed or actual inflation rate. This rate is fully adjusted for inflation.

Calculation of the indicator

The real interest rate can be calculated as the difference between the nominal interest rate and the level of inflation processes. In this way, the real interest rate is the following relation: r(p) = (1 + r(n)) / (1 + i) - 1, where the calculated indicator corresponds to the real interest rate, the second unknown term of the relation determines the nominal interest rate, and the third element characterizes the inflation rate.

Nominal interest rate

In the process of talking about lending rates, as a rule, we are talking about real rates ( the real interest rate is purchasing power of income). But the fact is that they cannot be observed directly. So, when concluding a loan agreement, an economic entity is provided with information on nominal interest rates.

The nominal interest rate should be understood as the practical characteristic of interest in quantitative terms, taking into account current prices. The loan is issued at this rate. It should be noted that it cannot be greater than or equal to zero. The only exception is a loan on a free basis. The nominal interest rate is nothing more than the percentage expressed in monetary terms.

Calculation of the nominal interest rate

Suppose, in accordance with the annual loan of ten thousand units of currency, 1200 units of currency are paid as interest. Then the nominal interest rate is equal to twelve percent per annum. After receiving a loan of 1200 monetary units, will the lender get rich? A competent answer to this question can only be known exactly how prices will change during the annual period. Thus, with an annual inflation rate of 8 percent, the lender's income will increase by only 4 percent.

The nominal interest rate is calculated as follows: r = (1 + percentage of income received by the bank) * (1 + rise in inflation rate) - 1 or R = (1 + r) × (1 + a), where the main indicator is the nominal interest rate, the second is the real interest rate, and the third is the growth rate of the inflation rate in the corresponding country .

conclusions

There is a close relationship between nominal and real interest rates, which, for absolute understanding, it is advisable to present as follows:

1 + nominal interest rate = (1 + real interest rate) * (price level at the end of the considered time period / at the beginning of the considered time period) or 1 + nominal interest rate = (1 + real interest rate) * (1 + inflation rate).

It is important to note that only the real interest rate reflects the real effectiveness and productivity of transactions made by the investor. It says about the increase in the funds of this economic entity. The nominal interest rate can only reflect the amount of cash growth in absolute terms. It does not take into account inflation. Increase in real interest rate indicates an increase in the purchasing power of the currency. And this is equal to the opportunity to increase consumption in future periods. So, this situation can be interpreted as a reward for current savings.

The nominal interest rate is the unadjusted market interest rate that reflects the current valuation of monetary assets.

The Real Interest Rate is the nominal interest rate minus the expected rate of inflation.

For example, the nominal interest rate is 10% per annum, and the projected inflation rate is 8% per annum. Then the real interest rate will be: 10 - 8 = 2%.

Nominal and real inflation rate

The difference between the nominal rate and the real one makes sense only in conditions of inflation or deflation. The American economist Irving Fisher put forward an assumption about the relationship between the nominal, real interest rate and inflation, called the Fisher effect, which states that the nominal interest rate changes by the amount at which the real interest rate remains unchanged.

In formula form, the Fisher effect looks like this:

i = r + pi

where i is the nominal interest rate;
r is the real interest rate;
πe is the expected rate of inflation.

For example, if the expected inflation rate is 1% per year, then the nominal rate will increase by 1% in the same year, therefore, the real interest rate will remain unchanged. Therefore, it is impossible to understand the process of making investment decisions by economic agents without taking into account the difference between the nominal and real interest rates.

Consider a simple example: let's say you intend to give someone a loan for one year in an inflationary environment, what is the exact interest rate you set? If the growth rate of the general price level is 10% per year, then setting the nominal rate at 10% per annum with a loan of CU1000, you will receive CU1100 in a year. But their real purchasing power will no longer be the same as a year ago.

Nominal income increment of CU100 will be "eaten" by 10% inflation. Thus, the distinction between nominal and real interest rates is important for understanding exactly how contracts are made in an economy with an unstable general price level (inflation and deflation).

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