1. REAL vs. NOMINAL Several economic variables come in two versions: “nominal” and “real” Three important examples are: 1.GDP 2.Wages 3.Interest rates In the first two cases we are going to look at the variables in their “rate of change” form. x = the rate of change of (growth rate of) GDP (where GDP = total spending) w = the rate of change of (growth rate of) wages Each of these can be described as “nominal.” x = by what percent did actual spending rise this year. w = by what percent did actual wages rise this year i = the interest rate actually paid or received NOMINAL VALUES i = the interest rate

2. REAL vs. NOMINAL 1.GDP 2.Wages 3.Interest rates q = the rate of change of real GDP (total output/production) wr = the rate of change of real wages REAL VALUES A real variable is one whose value has been adjusted to account for inflation (p = the inflation rate = the average rate of change of prices.) Each of these can be either “nominal” or “real” q = x – p. Real growth equals nominal growth, minus the inflation rate wr = w - p. Real wage growth equals nominal wage growth, minus the inflation rate. r = real interest rate r = i - p. The real interest rate equals the nominal rate, minus the inflation rate.

3. REAL vs. NOMINALExamples: If inflation were 7% … GDP … Wages … You get a 5% increase in your wage. This is nominal. If inflation is 2%, then your real wage increase is … the interest rate … Total spending (nominal GDP) rises by 6%. This is nominal. If inflation is 2%, then real GDP growth, the actual increase of goods and services produced, is … You lend me money at 8% interest. This is nominal. If inflation is 5%, the real interest rate is … If inflation were 8% … If inflation is 12% … Real rate = Nominal rate – inflation rate If inflation is -3%, (a 3% deflation), the real interest rate is … 3% 4% 3%. you would have a real wage decrease of 2%. That is, wr = 5% - 7% = -2% then real GDP fell by 2%. q = -2% (a recession) The real interest rate is -4%. You lost purchasing power by lending me the money. 11%

4. REAL vs. NOMINAL Three ways of saying the same thing: 2. Real rate = Nominal rate – inflation rate 1. Nominal rate = Inflation rate + real rate A nominal increase is split between a real increase and the amount “lost” to inflation The real rate is what is left when the effect of inflation is removed 3. Inflation rate = Nominal rate – real rate Inflation is the difference between nominal growth and real growth x = p + q q = x - p p = x - q w = p + wr i = p + r Examples: wr = w - p r = i - p p = w - wr p = i - r

5. Nominal growth =Inflation +Real growth xpq wpwr ipr