Nominal versus real: what inflation leaves of a yield

Why it matters

On one date, Kitalpha records two ten-year yields from the same borrower. The plain 10-year Treasury record shows 5.00% as of 2026-09-15. The 10-year inflation-indexed record, for a security whose principal is adjusted for consumer prices, shows 2.62%. Same borrower, same ten years, two different prices of time. A saver who watches a balance rise from one year to the next might ask which of the two describes what the money can pay for when it comes back. One counts dollars; the other counts what dollars command; and the gap between them is a number worth reading.

The concept

A nominal interest rate is a rate quoted in money. It says how fast a count of dollars rises: lend US$1,000 at 5% for a year and US$1,050 comes back. Every plain Treasury yield on Kitalpha is a nominal rate. What the quote leaves out is what those dollars can pay for, and that depends on prices.

Inflation is the rate at which the general level of prices rises over a period. Purchasing power is what a sum of money commands in goods and services at the prices of the day. If prices rise by 5% over the year, the US$1,050 repaid pays for exactly what US$1,000 paid for at the start: the dollar count is higher and the purchasing power is unchanged. If prices rise by 7%, the holder has more dollars and less purchasing power than a year earlier. The balance rose; the saver is poorer in goods. That is the error this lesson targets: reading a rising balance as rising purchasing power, without asking what prices did.

A real interest rate is the rate measured in purchasing power rather than in money: the growth in what the money lent can pay for. The relation between the three quantities is named for the economist Irving Fisher and, to a close approximation, reads nominal rate ≈ real rate + expected inflation. Rearranged, real ≈ nominal − inflation. The approximation drops a small cross-term; the exact form multiplies, (1 + nominal) = (1 + real) × (1 + inflation), and at rates of a few percent a year the two versions differ by a small fraction of a percentage point.

The word “expected” matters. A lender setting a nominal rate today cannot know what inflation over the loan’s life turns out to be, so the nominal rate embeds a view of inflation ahead, and the real rate earned is known only afterwards, once the price index for the period has been published. Two real rates therefore exist: one implied by prices at the start, one measured afterwards. This lesson works with the first, because a market price for it is published every trading day.

That price comes from a second kind of security. The U.S. Treasury issues inflation-indexed securities whose principal is adjusted by the consumer price index. Because the price adjustment is built into the security, its quoted yield is a real yield: what the holder gets over and above inflation. Kitalpha records this yield for the five-year and ten-year tenors beside the plain nominal yield. Subtract the real yield from the nominal yield and the result is the inflation rate at which the two securities would leave a holder equally well off over the tenor: the breakeven inflation rate. It is a property of two prices, computed rather than measured, and it moves on every day that either record moves. It is the inflation the two prices jointly imply, and nobody’s promise about the price index.

The visual plots the two ten-year records over roughly a year of trading days, nominal solid and real dashed. Look for the vertical distance between the lines on any date: that distance is the breakeven, and notice whether it holds steady while both lines move together, or opens and closes on its own.

Worked example

Take the two ten-year records from the opening: the plain 10-year Treasury yield, quoted at 5.00% as of 2026-09-15, and the 10-year inflation-indexed yield, quoted at 2.62% as of 2026-09-15. The steps read each yield from its record, subtract to find the breakeven, then run the exact relation beside it. Every figure below comes from the named record on the date shown.

Read the steps in order. The first is the nominal rate: the price of time counted in dollars. The second is the real rate: the same price counted in purchasing power, because the security behind it has its principal adjusted for consumer prices. The third is their difference, the inflation rate the two prices jointly imply over ten years, in percentage points. The fourth runs the exact multiplicative relation instead of the subtraction, and the last line shows how far the shortcut sits from it: a gap measured in basis points rather than percentage points, which is why the relation is written with an approximately-equals sign. Neither yield is a measurement of inflation; only the price index, published monthly, measures that. A balance lent at the first rate grows in dollars; whether it grows in what it can pay for is the question the second rate answers.

Faded example

Now the five-year pair: the plain 5-year Treasury yield, quoted at 4.83% as of 2026-09-15, and the 5-year inflation-indexed yield, quoted at 2.42%. Both yields are given below. Complete the last step yourself: the five-year breakeven inflation rate, in percentage points. Then reveal the answer and compare.

Retrieval check

Mark your confidence before each answer. Every option carries an explanation; read the ones you rejected too, because the distractors are the errors this lesson is about.

Your summary