# Nominal Interest Rate

## What is the 'Nominal Interest Rate'

The interest rate before taking inflation into account. The nominal interest rate is the rate quoted in loan and deposit agreements. The equation that links nominal and real interest rates is:
(1 + nominal rate) = (1 + real interest rate) (1 + inflation rate).
It can be approximated as nominal rate = real interest rate + inflation rate.

Next Up

## BREAKING DOWN 'Nominal Interest Rate'

To avoid purchasing power erosion through inflation, investors consider the real interest rate, rather than the nominal rate. One way to estimate the real rate of return in the U.S. is to observe the interest rates on Treasury Inflation-Protected Securities (TIPS). The difference between the yield on a Treasury bond and the yield on TIPS of the same maturity provides an estimate of inflation expectations in the economy.

For example, if the nominal interest rate offered on a three-year deposit is 4% and the inflation rate over this period is 3%, the investorâ€™s real rate of return would be 1%. While the real rate is low, at least it will preserve the investorâ€™s purchasing power. On the other hand, if the nominal interest rate is, say, 2% in an environment of 3% inflation, the investorâ€™s purchasing power would erode by 1% per annum.

Central banks set short-term nominal interest rates, which then form the basis for other interest rates charged by banks and financial institutions. Nominal interest rates may be held at artificially low levels after a major recession to stimulate economic activity through low real interest rates. A necessary condition for such stimulus measures is that inflation should not be a present or near-term threat. Conversely, during inflationary times, central banks may overestimate the inflation level and keep nominal interest rates too high. The resulting elevated level of real interest rates may have serious economic repercussions.

RELATED TERMS
1. ### Real Interest Rate

An interest rate that has been adjusted to remove the effects ...
2. ### Fisher Effect

An economic theory proposed by economist Irving Fisher that describes ...
3. ### Real Rate Of Return

The annual percentage return realized on an investment, which ...
4. ### Nominal Rate Of Return

The amount of money generated by an investment before expenses ...
5. ### Nominal Value

The stated value of an issued security. Nominal value in economics ...
6. ### Inflation-Protected Security - ...

A type of fixed-income investment that guarantees a real rate ...
Related Articles
1. Markets

### Understanding Interest Rates: Nominal, Real And Effective

Interest rates can be broken down into several subcategories that incorporate various factors such as inflation. Smart investors know to look beyond the nominal or coupon rate of a bond or loan ...
2. Investing

### What Does Nominal Mean?

Nominal refers to an unadjusted value or change in value.
3. Investing

### What is a Nominal Value?

The nominal value of a security, such as a stock or bond, remains fixed for the duration of its life.
4. Markets

### Understanding the Fisher Effect

The Fisher effect states that the real interest rate equals the nominal interest rate minus the expected inflation rate.
5. Markets

### Interest Rates: Nominal and Real

An interest rate is the cost of borrowing money, expressed as a percentage of the loan amount. Interest rates are the primary yardstick for measuring how much return lenders will get. However, ...
6. Markets

### How Interest Rates Can Go Negative

Central banks from Europe to Japan have implemented a negative interest rate policy (NIRP) in order to stimulate economic growth.
7. Markets

### What's a Real Rate of Return?

A real rate of return is an annual percentage investment return thatâ€™s adjusted for inflation, taxes or other factors.
8. Markets

### The International Fisher Effect: An Introduction

The Fisher models have the ability to illustrate the expected relationship between interest rates, inflation and exchange rates.
9. Markets

### A Red Flag to the U.S. Equity Market: Rate Hikes

Discover why the Federal Reserve may raise interest rates in 2016, why that might be necessary and why equity markets might not like it.
10. Markets

### The Taylor Rule: Calculating Monetary Policy

The Taylor Rule suggests how the central bank should change interest rates to account for inflation and other economic conditions.
RELATED FAQS
1. ### What is the difference between real and nominal interest rates?

Learn what nominal interest rates and real interest rates are, how real interest rate takes into account the inflation rate, ... Read Answer >>

3. ### How does the Fisher effect illustrate returns on bonds?

Learn how the Fisher effect shows the impact of expected future increases in inflation on the prices of bonds and their interest ... Read Answer >>

Hot Definitions
1. ### GBP

The abbreviation for the British pound sterling, the official currency of the United Kingdom, the British Overseas Territories ...
2. ### Diversification

A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique ...
3. ### European Union - EU

A group of European countries that participates in the world economy as one economic unit and operates under one official ...
4. ### Sell-Off

The rapid selling of securities, such as stocks, bonds and commodities. The increase in supply leads to a decline in the ...
5. ### Brazil, Russia, India And China - BRIC

An acronym for the economies of Brazil, Russia, India and China combined. It has been speculated that by 2050 these four ...
6. ### Brexit

The Brexit, an abbreviation of "British exit" that mirrors the term Grexit, refers to the possibility of Britain's withdrawal ...