Figure 2 shows real and nominal interest rates in the US. economy since 1965. The nominal interest rate in this figure is the rate on 3-month Treasury bills (although data on other interest less would be similar) The real interest rate is computed by subtracting the rate of inflation from this nominal interest rate. Here the inflation rate is measured as the percentage change in the consumer price index. One feature of this figure is that the nominal interest rate always exceeds the real interest rate. This reflects the fact that the US. economy has experienced rising consumer prices in every year during this period. By contrast, if you looked at the US. economy during the late 19th century or at the Japanese economy in some recent years, you will find periods of deflation. During deflation, the real interest rate exceeds the nominal interest rate The figure also shows that real and nominal interest rates do not always move together. For example, in the late 1970s, nominal interest rates were high. But because inflation was very high, real interest rates were low. Indeed, during much of the 1970s, real interest rates were negative, for inflation eroded people’s savings more quickly than nominal interest payments increased them. By contrast, in the late 1990s, nominal interest rates were lower than they had been two decades earlier. But because inflation was much lower, real interest rates were higher. The early 2000s were a period when both real and nominal interest rates were row. In the coming chapters, we will examine the economic forces that determine both real and nominal interest rates. •

figure 2 Real and Nominal Interest Rates.
This figure shows nominal and real interest rates using annual data since 1965. The nominal interest rate is the rate on a 3-month Treasury bill. The real interest rate is the nominal interest rate minus the inflation rate as measured by the consumer price index. Notice that nominal and real interest rates often do not move together.

Real and Nominal Interest Rates.

Real and Nominal Interest Rates.

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