nominal interest rate

(noun)

The rate of interest before adjustment for inflation.

Related Terms

Examples of nominal interest rate in the following topics:

  • Differences Between Real and Nominal Rates

    • Nominal rate refers to the rate before adjustment for inflation; the real rate is the nominal rate minus inflation: r = R - i or, 1+r = (1+r)(1+E(r)).
    • The real rate is the nominal rate minus inflation.
    • If the lender is receiving 8% from a loan and inflation is 8%, then the real rate of interest is zero, because nominal interest and inflation are equal.
    • The real rate can be described more formally by the Fisher equation, which states that the real interest rate is approximately the nominal interest rate minus the inflation rate: 1 + i = (1+r) (1+E(r)), where i = nominal interest rate; r = real interest rate; E(r) = expected inflation rate.
    • The relationship between real and nominal interest rates is captured by the formula.

  • The Fisher Effect

    • We only discussed nominal interest rates.
    • We did not adjust the nominal interest rates for inflation.
    • The Fisher Effect relates nominal and real interest rates and we define the notation as:
    • Financial analysts always write interest rates for financial instruments in nominal terms.
    • If the government wants low nominal interest rates, then the public and investors must believe the inflation rate will be low.

  • Macroeconomic Factors Influencing the Interest Rate

    • Taylor explained the rule of determining interest rates using three variables: inflation rate, GDP growth, and the real interest rate.
    • In particular, the rule stipulates that for each 1% increase in inflation, the Central Bank should raise the nominal interest rate by more than one percentage point.
    • According to Taylor's original version of the rule, the nominal interest rate should respond to divergences of actual inflation rates from target inflation rates and of actual Gross Domestic Product (GDP) from potential GDP:
    • In this equation, it is the target short-term nominal interest rate (e.g., the federal fund rates in the United States), πt is the rate of inflation as measured by the GDP deflator, π*t is the desired rate of inflation, r*t is the assumed equilibrium real interest rate, yt is the logarithm of real GDP, and y*t is the logarithm of potential output, as determined by a linear trend.
    • Describe how the nominal interest rate is influenced by inflation, output, and other economic conditions

  • Comparing Interest Rates

    • However, it is not enough to simply compare the nominal values of two interest rates to see which is higher.
    • The reason why the nominal interest rate is only part of the story is due to compounding.
    • To find the real interest rate, simply subtract the expected inflation rate from the nominal interest rate.
    • Thus, Company 2 is the better investment, even though Company 1 pays a higher nominal interest rate.
    • The nominal interest rate is approximately the sum of the real interest rate and inflation.

  • Inflation Premium

    • An inflation premium is the part of prevailing interest rates that results from lenders compensating for expected inflation by pushing nominal interest rates to higher levels.
    • Actual interest rates (without factoring in inflation) are viewed by economists and investors as being the nominal (stated) interest rate minus the inflation premium.
    • The Fisher equation in financial mathematics and economics estimates the relationship between nominal and real interest rates under inflation.
    • In economics, this equation is used to predict nominal and real interest rate behavior.
    • Letting r denote the real interest rate, i denote the nominal interest rate, and let π denote the inflation rate, the Fisher equation is: i = r + π.

  • Calculating the Yield of a Single-Period Investment

    • Nominal APR is simply the interest rate multiplied by the number of payment periods per year.
    • However, since interest compounds, nominal APR is not a very accurate measure of the amount of interest you actually accrue.
    • Interest usually compounds, so there is a difference between the nominal interest rate (e.g. monthly interest times 12) and the effective interest rate.
    • The Annual Percentage Yield is a way or normalizing the nominal interest rate.
    • Basically, it is a way to account for the time factor in order to get a more accurate number for the actual interest rate.inom is the nominal interest rate.N is the number of compounding periods per year.

  • The Demand for Money

    • Generally, the nominal demand for money increases with the level of nominal output and decreases with the nominal interest rate.
    • Specific to the liquidity function, L(R,Y), R is the nominal interest rate and Y is the real output.
    • However, when the demand for money is not stable, real and nominal interest rates will change and there will be economic fluctuations.
    • The interest rate is the rate at which interest is paid by a borrower (debtor) for the use of money that they borrow from a lender (creditor).
    • Interest-rate targets are a tool of monetary policy.

  • Calculating Values for Different Durations of Compounding Periods

    • But suppose you want to convert the interest rate into an annual rate.
    • The EAR can be found through the formula in where i is the nominal interest rate and n is the number of times the interest compounds per year (for continuous compounding, see ).
    • In this equation, A(t) corresponds to FV, A0 corresponds to Present Value, r is the nominal interest rate, n is the number of compounding periods per year, and t is the number of years.
    • The effective annual rate for interest that compounds more than once per year.
    • Finding the FV (A(t)) given the PV (Ao), nominal interest rate (r), number of compounding periods per year (n), and number of years (t).

  • Drivers of Market Interest Rates

    • A market interest rate is the rate at which interest is paid by a borrower for the use of money that they borrow from a lender in the market.
    • In a free market there will be a positive interest rate.
    • Different investments effectively compete for funds, boosting the market interest rate up.
    • The greater the risk is, the higher the market interest rate will get.
    • where in is the nominal interest rate on a given investment, ir is the risk-free return to capital, pe = inflationary expectations, i*n = the nominal interest rate on a short-term risk-free liquid bond (such as U.S.

  • Relationship Between Expectations and Inflation

    • Anything that is nominal is a stated aspect.
    • Suppose you are opening a savings account at a bank that promises a 5% interest rate.
    • This is the nominal, or stated, interest rate.
    • The real interest rate would only be 2% (the nominal 5% minus 3% to adjust for inflation).
    • The difference between real and nominal extends beyond interest rates.