What is the difference between nominal and real interest rates? To understand the answer to this question, it is first necessary to explain what these two concepts mean. Nominal interest rate refers to the percentage return or cost of an investment or loan. For example, if 100 TL deposited in a bank account reaches 105 TL one year later, the nominal interest rate is 5%. The real interest rate is the interest rate obtained by subtracting the inflation rate from the nominal interest rate. The inflation rate measures the change in the general price level. For example, if prices have increased by 3% in a year, the inflation rate is 3%. In this case, an investment with a nominal interest rate of 5% has a real interest rate of 2% (5% - 3% = 2%). The real interest rate shows the change in the purchasing power of the investment or debt. The real value of an investment with a nominal interest rate of 5% is 105 TL when prices remain constant, and 102 TL when prices increase by 3%.
What is the significance of the difference between nominal and real interest rates? This difference has a significant impact on economic decisions. For example, when real interest rates are high, saving becomes more attractive. Because the money saved has more purchasing power in the future. When real interest rates are low, it becomes more attractive to spend or borrow. Because money spent or borrowed will have less purchasing power in the future. Real interest rates also affect investment decisions. When real interest rates are high, it becomes more costly to invest. Because the interest paid on the investment will have more purchasing power in the future. Investing becomes more profitable when real interest rates are low. Because the interest paid on the investment will have less purchasing power in the future.
How might the relationship between nominal and real interest rates change? This relationship may change depending on shocks or policies in the economy. For example, in the event of an economic crisis, demand falls and prices begin to fall. In this case, the inflation rate can be negative (deflation). This can cause the nominal interest rate to be lower than the real interest rate. In this case, the real interest rate rises and negatively affects saving and investment decisions. On the other hand, in the case of an economic recovery, demand increases and prices start to rise. In this case, the inflation rate can be positive. This can cause the nominal interest rate to be higher than the real interest rate. In this case, the real interest rate falls and positively affects saving and investment decisions.