# Nominal vs Real Interest Rate  ## Difference Between Nominal and Real Interest Rate

The nominal rate is that rate of return which considers the monetary value but ignores inflation during calculation. In contrast, the real rate includes inflation for computation and thus provides transparency to the investors by reflecting the opportunity value.

For eg:
Source: Nominal vs Real Interest Rate (wallstreetmojo.com)

The difference between nominal and real interest rate can be understood with the help of the Fisher equation. The Fisher effect states that the is simply the sum of the real interest rate and expected inflation.

Nominal Interest Rate = Real Interest Rate + Expected Inflation

The idea behind the Fisher effect is that real rates are relatively stable and changes in interest rates are driven by changes in expected inflation. This is consistent with .

Investors are exposed to the risk that inflation and other future outcomes may be different than expected. Investors require an additional return (a risk premium) for bearing this risk, which we can consider the third component of a nominal interest rate.

Nominal Interest Rate Formula = Real Interest Rate + Expected Inflation + Risk Premium

Essentially the difference between these rates is inflation. It is important to understand these rates because nominal rates do not show the entire story for investment returns or the economy.

### Nominal Interest Rate vs Real Interest Rate Infographics

Let’s see the top differences between nominal vs real interest rate.

For eg:
Source: Nominal vs Real Interest Rate (wallstreetmojo.com)

### Conclusion

Understanding interest rates are important as they will help evaluate and compare different investments and loans over time. In economics, nominal and real interest rates are two important concepts. GDP (Gross domestic product) of a country is quoted in nominal as well as real interest rate terms.

The Fisher equation as stated above helps in determining this rate precisely. The nominal rate describes the interest rate without any correction for the effects of inflation and the real interest rate refers to the interest rate adjusted for the effects of inflation.

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