Nominal interest rates reflect real interest rates plus an inflation premium.

When deciding whether or not to lend or borrow money, there are two primary factors to consider: (1) the interest rate and (2) the expected rate of inflation. It is important to realize that a loan made at an interest rate of 10% in an environment where inflation is running at 10% yields a return that has exactly the same buying power as did the original amount of money before the loan was made. The lender gets nothing of real value in return for having made the loan.

The actual rate of interest charged on a loan is called the nominal rate. The nominal rate minus the rate of inflation is referred to as the real rate of interest. So, a loan made with a 10% interest rate in an environment of 4% inflation yields a real rate of interest of 6%.