Nominal interest (rN) rate is the interest that does not take inflation (i) into account vs real interest (rR) does. This is the main difference between nominal and real interest rates. Nominal interest rates are used in real life financial contracts such as bonds, loans etc. but since there is a phenomenon of inflation in real world, we have to take inflation into account when we are calculating the real interest. We can use below formula to calculate real interest rate if we know the nominal rate and expected inflation. rR = (1 + rN) / (1 + i) – 1 This formula is called Fisher Equation which named after famous economist Irving Fisher. To make it more easy to understand, let’s make a simple example: Assume that nominal interest rate is 15% and expected inflation is 7%, with that information we can easily find real interest rate. rR = (1 + 0.15) / (1 + 0.07) – 1 = 0.0748 which is around 7.48%. Additionally, there is International Fisher Effect which is a theory showing t...
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