What's the Difference Between Nominal

and Real?
Real Variables and Nominal Variables Explained
From Mike MoIIatt, Iormer About.com Guide
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O 3omi3al variables
O real variables
O 3omi3al gdp
O real i3terest rates
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Q:] I'm lear3i3g eco3omics a3d I keep eari3g te terms 3omi3al a3d real all te time to
describe ti3gs like i3terest rates. Wat's te diIIere3ce betwee3 3omi3al a3d real?
:]Great questio3
Ge3erally a real variable, suc as te real i3terest rate, is o3e were te eIIects oI i3Ilatio3
ave bee3 Iactored i3. A 3omi3al variable is o3e were te eIIects oI i3Ilatio3 ave 3ot bee3
accou3ted Ior. A Iew examples illustrate te diIIere3ce:
Nominal Interest Rates vs Real Interest Rates
Suppose we buy a 1 year bo3d Ior Iace value tat pays 6 at te e3d oI te year. We pay
$100 at te begi33i3g oI te year a3d get $106 at te e3d oI te year. Tus te bo3d pays a3
i3terest rate oI 6. Tis 6 is te 3omi3al i3terest rate, as we ave 3ot accou3ted Ior
i3Ilatio3. We3ever people speak oI te i3terest rate tey're talki3g about te 3omi3al i3terest
rate, u3less tey state oterwise.
Now suppose te i3Ilatio3 rate is 3 Ior tat year. We ca3 buy a basket oI goods today a3d it
will cost $100, or we ca3 buy tat basket 3ext year a3d it will cost $103. II we buy te bo3d
wit a 6 3omi3al i3terest rate Ior $100, sell it aIter a year a3d get $106, buy a basket oI
goods Ior $103, we will ave $3 leIt over. So aIter Iactori3g i3 i3Ilatio3, our $100 bo3d will
ear3 us $3 i3 i3come; a real i3terest rate oI 3. Te relatio3sip betwee3 te 3omi3al i3terest
rate, i3Ilatio3, a3d te real i3terest rate is described by te Fiser Equatio3:
Real Interest Rate Nominal Interest Rate - Inflation
II i3Ilatio3 is positive, wic it ge3erally is, te3 te real i3terest rate is lower ta3 te
3omi3al i3terest rate. II we ave deIlatio3 a3d te i3Ilatio3 rate is 3egative, te3 te real
i3terest rate will be larger.
2 Nominal GDP Growth vs Real GDP Growth
GDP, or Gross Domestic Product is te value oI all te goods a3d services produced i3 a
cou3try. Te Nomi3al Gross Domestic Product measures te value oI all te goods a3d
services produced expressed i3 curre3t prices. O3 te oter a3d, Real Gross Domestic
Product measures te value oI all te goods a3d services produced expressed i3 te prices oI
some base year. A3 example:
Suppose i3 te year 2000, te eco3omy oI a cou3try produced $100 billio3 wort oI goods
a3d services based o3 year 2000 prices. Si3ce we're usi3g 2000 as a basis year, te 3omi3al
a3d real GDP are te same. I3 te year 2001, te eco3omy produced $110B wort oI goods
a3d services based o3 year 2001 prices. Tose same goods a3d services are i3stead valued at
$105B iI year 2000 prices are used. Te3:
Year 2000 Nominal GDP $00B, Real GDP $00B
Year 200 Nominal GDP $0B, Real GDP $05B
Nominal GDP Growth Rate 0
Real GDP Growth Rate 5
O3ce agai3, iI i3Ilatio3 is positive, te3 te Nomi3al GDP a3d Nomi3al GDP Growt Rate
will be less ta3 teir 3omi3al cou3terparts. Te diIIere3ce betwee3 Nomi3al GDP a3d Real
GDP is used to measure i3Ilatio3 i3 a statistic called Te GDP DeIlator.
3 Nominal Wages vs Real Wages
Tese work i3 te same way as te 3omi3al i3terest rate. So iI your 3omi3al wage is $50,000
i3 2002 a3d $55,000 i3 2003, but te price level as rise3 by 12, te3 your $55,000 i3 2003
buys wat $49,107 would ave i3 2002, so your real wage as go3e do3e. You ca3 calculate
a real wage i3 terms oI some base year by te Iollowi3g:
Real Wage Nominal Wage / + Increase in Prices Since Base Year
Were a 34 i3crease i3 prices si3ce te base year is expressed as 0.34.
4 Other Real Variables
Almost all oter real variables ca3 be calculated i3 te ma33er as Real Wages. Te Federal
Reserve keeps statistics o3 items suc as te Real a3ge i3 Private I3ve3tories, Real
Disposable I3come, Real Gover3me3t Expe3ditures, Real Private Reside3tial Fixed
I3vestme3t, etc. Tese are all statistics wic accou3t Ior i3Ilatio3 by usi3g a base year Ior
prices.
II you'd like to ask a questio3 about 3omi3al variables, real variables, or a3y oter topic or
comme3t o3 tis story, please use te Ieedback Iorm.