Does the nominal interest rate reflect actual purchasing power?

The nominal interest rate does not reflect actual purchasing power because it does not take inflation into account. The nominal interest rate is the stated rate of interest on a loan or investment, and it represents the rate at which money can grow without adjustments for changes in the price level.

Purchasing power is influenced by inflation, which erodes the value of money over time. When inflation is present, even if the nominal interest rate is positive, the real interest rate—which adjusts for inflation—can be lower or even negative. The real interest rate provides a more accurate representation of the actual increase in purchasing power that an investor or saver experiences.

For instance, if an investor earns a nominal interest of 5% but the inflation rate is 3%, the real interest rate is only 2%. This means that while the nominal interest rate appears to give a return, the actual purchasing power gained is much lower due to the effects of inflation. Therefore, the correct understanding is that the nominal interest rate alone does not reflect the changes in purchasing power, particularly in environments where inflation is a factor.