Distinguish between the nominal and the real interest rate. Which one is more important and why?
Nominal interest rate is the interest rate that has not been adjusted to the rate of inflation, real interest rate is the interest rate that has been adjusted to the rate of inflation. Real interest rates give a true reflection of the cost of borrowing. The distinction between real and nominal interest rates is important because the real interest rate, which reflects the real cost of borrowing, is likely to be a better indicator of the incentives to borrow and lend. It appears to be a better guide to how people will be affected by what is happening in credit markets.