What's the difference between nominal and real interest rates?
If your savings account pays 3% but inflation runs at 4%, your balance grows while its buying power shrinks—a real rate of about −1%. The Fisher equation sums it up: nominal ≈ real + expected inflation. Lenders demand compensation for inflation, so when expected inflation rises one point, nominal rates should too (Fisher, 1930).
Does the Fisher effect hold in practice?
Over the long run, high-inflation countries do tend to have higher interest rates, but in the short run Fed policy and the business cycle often break the link (Mishkin, 1992). The international Fisher effect extends the idea to currencies: interest-rate gaps should reflect inflation gaps, so high-rate currencies tend to depreciate (exchange rate theory). The same logic underlies real discount rates.
FAQ
- What happens when real rates are negative?
- Saving loses value in real terms, which encourages borrowing and can inflate asset prices.
- How can I see the real interest rate?
- Treasury Inflation-Protected Securities (TIPS) yields are a market measure of real rates.
Sources reviewed: 2026-10-25
References
- Fisher, I. (1930). The theory of interest. Macmillan.
- Mishkin, F. S. (1992). Is the Fisher effect for real? Journal of Monetary Economics, 30(2), 195–215.