Question

Refer to the diagram to the right where a nominal interest rate (the 6-month annualized Treasury rate) and the rate of inflation are plotted. In which of the three decades (1970-79, 1980-89, 1990-99) is the inflation rate the e 14- a 13 most stable? The inflation rate is most stable during the In which of the three decades does the economy experience disinflation? Disinflation is experienced during the In which of the three decades is the real interest rate, on average, the highest? 0 12 On average, the real interest rate is highest during the 1970 1975 1980 1985 1990 1995 2000 2005 Year

Answer 1

A) Stability in inflation rate implies minimum fluctuation. It can be seen that the inflation line is the least fluctuating (changing by just small bits) in the decade of 1990-1999. It starts at nearly 5% to end at around 3.9% in the graph.

Other decades have major fluctuations with the inflation rate going extremely volatile.

Correct Answer : 1990-1999

B) Disinflation implies a fall in the rate of inflation. In the decade of 1990-1999, the inflation rate follows a decline from nearly 5% to end at around 3.9%. But the rate has been stable, not falling much. In the period of 1980-1989, the rate of inflation falls drastically from 13.5% to 3% approximately. It rises a little to decline again to 1.8% (approx). This evidently shows a sign of disinflation.

Correct Answer : 1980-1989

C) Real rate of interest = Nominal rate of interest - Inflation

The Real rate of interest is the highest when the gap between the nominal rate of interest and inflation is the highest hat is, the nominal rate of interest is all time high and the inflation in the economy is low.

Thus, to see when the real rate of interest is the highest, we see where the gap between the nominal rate of interest and inflation is the maximum, with the former greater than the latter.

It can be seen that in the decade of 1980-1989, the average difference between the nominal rate of interest and inflation is the maximum. The difference is significant in the decade of 1990-1999 as well, but the gap is much more stable during 1980-1989. Thus, the real rate of interest is the highest (on an average) during 1980-1989.

Correct Answer : 1980-1989