Question

Suppose the real interest rate is 3% and expected inflation is 3%. What is the nominal interest rate?

nominal interest rate: = _______ %

All else equal, if inflation decreases by 0 %, what will happen to the nominal interest rate?

• The real interest rate will decrease by 0 %.

• The nominal interest rate will decrease by 0 %.

• The nominal interest rate will increase by 0 %.

• The real interest rate will increase by 0 %.

What do economists call the relationship between the nominal interest rate and the inflation rate?

• shoeleather costs

• Leontief paradox

• Taylor rule

• Fisher equation

Answer 1

We can calculate the real interest rate using the following formula,

Real interest rate = Nominal interest rate - Rate of Inflation

Nominal interest rate = Real interest rate + Inflation rate

Given, Real interest rate =3%, Expected Inflation = 3%

Nominal interest rate = 6%

All else equal, if inflation decreases to 0%, what will happen to the nominal interest rate?

Nominal interest rate = Real interest rate + Inflation

When inflation decreases by 0% then there will be no change in nominal interest rate.

Let us assume Real interest rate = 5%, rate of inflation = 3%

Then, nominal interest rate = 5+3 = 8%

Now assume when inflation rises by 1%(all else equal)

Nominal interest rate = 5% + 4% = 9%

So, nominal interest rate too rose by 1%.

Answer is Nominal interest rate will increase by 0%.

Relationship between Nominal interest rate and Inflation is known as

Fisher Equation.

Please contact if having any query thank you.