What is the impact of nominal interest rates in comparison to real interest rates?

Nominal interest rates are indeed influenced by inflation, which makes the choice that identifies this relationship correct. Nominal rates represent the interest rates observed in the market without adjusting for the effects of inflation. Since inflation affects the purchasing power of money, nominal rates must incorporate expectations regarding future inflation to provide investors with adequate compensation for holding cash or lending to borrowers.

When inflation rises, nominal interest rates tend to increase to maintain the real return for lenders, as they seek to preserve their purchasing power. Conversely, if inflation expectations decrease, nominal rates may also drop. This relationship emphasizes the importance of understanding nominal rates in the context of economic conditions and inflationary pressures.

In contrast, real interest rates are derived from nominal rates by subtracting inflation. They represent the true cost of borrowing and the true yield on investments adjusted for inflation, which is why they are crucial for assessing long-term investment returns. Each of the other options fails to capture this essential connection between nominal rates and inflation directly, highlighting the foundational role that inflation plays in shaping nominal interest rates.