Real rate and nominal rate:

We have spoken till now of the real rate of interest. This rate measures the amount of commodity in the next period that can be exchanged for one unit of the commodity this period. This will be different from the nominal rate, which refers to the amount of money  to be repaid next period per unit borrowed now. The two rates are related to each other by a relation called Fisher's Law. It basically asserts that an exchange between money now for money tomorrow must imply the same rate of exchange between the commodity now and later, as implied by the real rate. But instead of this, supposed we had sold the commodity off at the  present price P₁ and invested the amount earned in a loan at the nominal rate (1+i) getting back P₁ (1+i) Assume that the real rate is 1+r; this means that by giving one unit of the commodity now we can get 1+r units of the commodity tomorrow. Let us see how much it represents in terms of commodity tomorrow. To do this we must divide by the price

Here the term in parentheses is the inflation rate.