Real vs. nominal

Nominal prices or values refer to the economic value expressed in fixed money terms. Real prices or values adjust the nominal value to account for inflation, or changes in the general price level over time.

For example, real income will measure the actual purchasing power of the earner. As the price level rises, even if a wage earner’s nominal salary may stay the same, the amount of goods and services he can purchase with the same salary will decline in real terms. The same applies to other economic values, such as prices, GDP, interest rates, returns, etc. If the inflation rate is greater than 0, the nominal interest rate will be grater than the real interest rate.

(1 + nominal rate) = (1 + real rate) * (1 + inflation rate)

For example, below is a graph of the nominal against real returns of asset ‘A’ over time. We can see that the nominal return is always higher than the real return, as inflation was positive during this period. (Note that the numbers are purely hypothetical.)