What is the difference between nominal interest rate and real interest rate, and why does this matter to savers and borrowers?
Answer (1)
The nominal interest rate is the interest rate you see at the bank or on a loan—it’s the actual percentage stated. The real interest rate, however, shows how much you’re actually earning or paying after taking inflation into account. Understanding the difference between these two is very important, especially for savers and borrowers.Let’s say you save money in a bank at a nominal interest rate of 5%. This means if you deposit ₱10,000, after one year you’ll earn ₱500. But if inflation is 4%, the real interest rate is only 1%. That’s because the money you earned (₱500) has less purchasing power—what cost ₱10,000 last year may now cost ₱10,400.This matters for savers because if inflation is higher than the nominal rate, you’re actually losing money in real terms. For example, many Filipinos save in “time deposits” or savings accounts. If the interest rate is 2% and inflation is 5%, then their money loses value each year.On the other hand, borrowers benefit from inflation. If you borrow ₱100,000 at a 6% interest rate, but inflation is 8%, the real cost of your loan is actually -2%. You’re paying back the bank with pesos that are worth less than when you borrowed them.This happened in the Philippines in 2022 when interest rates on loans were slow to adjust, but inflation rose fast. Borrowers who took out loans earlier gained because they repaid in “weaker pesos,” while savers struggled to keep up.In conclusion, the real interest rate is what truly affects your wealth. Savers want high real interest rates to grow their money, while borrowers hope for low or even negative real rates. That’s why inflation and interest rates must always be studied together—especially in developing economies like the Philippines, where many people have small savings but are vulnerable to inflation.
