How are real and nominal related?
We define the real rate of interest as equaling the nominal rate of interest less the rate of inflation. We can write this as follows: R% = N% – I% Or, conversely: R% + I% = N% This formula creates an inverse relationship between real and nominal terms. When we plot the real versus the nominal interest rate over a period of time, using the same inflation assumption; then we will get graphs that are the mirror-image of each other. As it turns out, this inverse relationship goes much deeper. As an example, we have found that while nominal interest rates will ratchet upwards with inflation, real interest rates will ratchet downwards over time. This leads us to believe that a real monetary system can substantially reduce the cost of capital over time, thereby promoting a healthy economy.
