How do nominal interest rates differ from real interest rates?

Nominal interest rates represent the stated rate of interest without adjusting for inflation. This means they reflect the actual percentage increase in money that lenders charge borrowers for the use of their funds. In contrast, real interest rates account for inflation, allowing for a more accurate representation of the purchasing power of the money that will be repaid in the future.

Choosing the option that states nominal rates do not account for inflation highlights the essential distinction between nominal and real rates. Real interest rates provide insight into the actual increase in the purchasing power of money by taking inflation into consideration. This is crucial for understanding how the cost of borrowing and the return on investments actually translate into financial terms after adjusting for the effects of rising prices.

Understanding this difference helps in making informed decisions about savings, investments, and loans, as it provides clarity on the true cost and benefit of financial activities.