Real VI. Nominal Interest Rates

dollar or nominal terms and not in terms of trees or wine or cars. Interest is the yield’ on an investment measured in dollars per year per dollar of investment. But dollars can become distorted yardsticks. The prices of fish. trees. wine, and other goods change from year to year as the general price level rises due to inflation:!! We therefore need to find a real return on capital. one that measures the quantity of goods we get tomorrow for goods forgone today. As an example, say that you invested 1000 rubles in a Russian bond in 1995. Because you were offered a 70 percent interest rate, you might have looked forward to getting a hefty return, ending up with 1700′ rubles at the end of the year. But when you later look your money out to buy some consumer goods, you found that prices had risen 65 percent during 1995.

In terms of the real quantity of goods actually buy only 3 percent more (1.030 = 1.70/1.65) than you could have bought at the start of till’ year, In other words, if you had loaned 1000 market baskets of goods at the beginning of 1995 04 could have obtained only 1030 market baskets of goods the following year. The difference, between real nominal interest rates is particularly dramatic during periods of high.

We call the real yield, on funds the real interest rate, as opposed to the nominal interest rate, which is the dollar return on dollars invested. For low rates of interest and inflation. the real interest rate is close to the nominal interest rate minus the rate of
The real interest rate is the return on funds in terms of goods and services; we generally calculate the real interest rate as the nominal interest rate the rate of inflation. Table 14-1 shows nominal interest 100 different it over the last three decades.

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