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Can nominal interest rate be lower than the real interest rate?
It does not make sense for nominal to be lower than real, except I encountered this on a 4th year university test (as two given values).
It just occurred to me that perhaps it is possible during a deflationary period, as in, a period of negative inflation? Am I correct?
Assume that all rates are the effective annual rate, compounded annually. John M, you are referring to the Annual Percent Rate versus the Effective Annual Rate. The APR is a convention, and the EAR is what you are actually paying. "Real rate" as an economic term is the inflation adjusted interest rate.
3 Answers
- juiceboxLv 58 years agoFavorite Answer
nominal interest rate = real interest rate + expected inflation
If nominal interest rates are zero, and expected inflation is negative, then the real interest rate will be ABOVE the nominal interest rate.
Think of it like this:
nominal rates = 0
inflation = -2
real interest rate = nominal rate - expected inflation= 0- -2 = 2. The real interest rate is positive, while the nominal interest rate is 0. This is a perverse situation and cripples investment and exports.
This is what was happening in Japan, although it's been temporarily reversed for now as Shinzo Abe's promise of more vigorous monetary expansion and fiscal stimulus have raised expected inflation and reduced real rates.
So yes, you are correct; in deflationary periods the real interest rate could very well be ABOVE the nominal interest rate.
- ?Lv 78 years ago
You are correct. The nominal will be lower than the real during a period of negative inflation.
- John MLv 78 years ago
When the nominal interest rate is stated for the period of one year, but the interest is compounded monthly or daily, the nominal rate is always lower than the real interest rate if the interest rate is positive.
Nominal means as stated. Real interest rates are calculated according to the fine print, which often includes compounding that serves to increase the effective rate of interest earned by the lender.
