Question

An investment offers a 12.0 percent total return over the coming year. Bill Bernanke thinks the total real return on this investment will be only 3.5 percent. What does Bill believe the inflation rate will be over the next year?

Answer 1

In order to provide the answer to the above question, it is important to understand the three terms and then only we can come to a solution of the above question,

Real Return = Nominal Return - Inflation.

Real Return = Real Return can be defined as the return an individual/investor receives after the rate of inflation is taken into consideration or in simple words Inflation is being subtracted from the Nominal Return.

Nominal Return = The rate of return on investment without adjusting for inflation.

Inflation = Inflation can be termed as an increase in the price level of goods and service and by this cost of living also increased.

In the above question given values are

Total Return or Nominal Return = 12%

Total Real Return = 3.5%

Inflation rate =?

From the above formula, we can derive the inflation as

Inflation = Total return or Nominal Return - Real Return

Inflation = 12% - 3.5%

Inflation = 8.5%