Nominal Interest Rate Concept (TIN)
Type that is usually mentioned in the contracts in which the payment of interest is agreed and is characterized in that the inflation rate is not discounted (as opposed to the real interest rate, in which inflation is subtracted).
When the period of time foreseen for the calculation and settlement of interest coincides with the form of expression of the interest rate, a nominal interest rate is being used.
To calculate the total capital resulting from an operation carried out with a nominal interest rate, the following expression is used:
Cn = C0 (1+ni)
Examples:
1.- 4% per year, in an operation of 1,000 euros of principal with annual calculation and settlement of interest: the interest to be paid/received each year amounts to 40 euros.
2.- 2% per semester in an operation of 1,000 euros with semi-annual calculation and settlement of interest: the interest to be paid/received each semester amounts to 20 euros.
The problem is that the calculation period does not always coincide with the interest settlement period. This means that the cost (or benefit) of a certain financial product cannot be compared well. For the comparison to be homogeneous, the effective interest rate of the operation must be known, which is the one that equalizes the payments and collections of principal and interest of a product taking into account the moment in which they occur.
Under the hypothesis of the compound interest rate, the effective interest rate is constructed. Thus, for example, a loan with a nominal annual interest rate of 4%, whose interest is paid every six months, is a loan with an effective interest rate of 4.04%.
Ratio of real interest rate and nominal interest rate
The relationship between the nominal interest rate and the real interest rate was enshrined in the so-called Fisher Identity: the nominal interest rate is approximately the real interest rate plus the inflation rate (Nominal interest rate = Interest rate). real interest + inflation). Fisher’s identity is a derivative of the Quantitative Equation of Money. Fisher’s Identity is an estimated formula and, therefore, not exact, to define the difference between the real and nominal interest rate. At a practical level, all schools of economic thought accept the use of Fisher’s Identity, although they disagree on its theoretical foundations.
In this sense, since the nominal interest rate is directly related to the growth of fiduciary money, it is established, in an estimated way, that the increase in fiduciary money corresponds to inflation and can, therefore, be subtracted from the nominal interest rate to thus obtain the value of the real interest rate.
In an economy like ours, the relationship between nominal and real interest is distorted. The nominal interest rate is a price set by the Central Bank. Monetary policy is implemented through the setting of short-term interest rates (one day, one week, one month) and from there the different nominal interest rates are born depending on the term of the loan.
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