Nominal interest rate
This is one of the greatest misconceptions in economics. If real interest rate is the real rate of interest, the nominal interest rate is not the real thing. In fact it is the sum of the expected real interest rate plus the expected inflation rate over the duration of the loan. The sum of these two uncertain estimates does not give the investor a trustworthy number to make rational decisions by. The investor ends not knowing what the real interest rate of investment will be, as oposed to securities that deliberaty garantee a real rate like todays TIPS-Treasury Inflation Protected Securities
When comparing interest rates, nominal interest rates and effective interest rates have to be distinguished. An interest rate is called nominal if the period of time after that the interest is credited (e.g. a month) is not identical to the basic time unit (normally a year).
Example
Let's assume an annual interest rate of 6% which is credited after each month. This means that an interest of 6%/12 = 0.5% is credited every month. After one year, the initial capital is increased by the factor (1+0.005)12 ≈ 1.0616. As a result, this nominal interest rate is equivalent to an effective interest rate of 6.16%.
See also
