Question

12/12 ​(Related to Checkpoint​ 9.6)  ​(Inflation and interest rates​) What would you expect the nominal rate of interest to be if the real rate is 4.2 percent and the expected inflation rate is 6.6 ​percent? The nominal rate of interest would be nothing​%. ​(Round to two decimal​ places.)

Answer 1

Answer)

Real rate of interest: It is the rate of interest which is inflation adjusted. In other words, the real rate of the interest is the actual rate earned by an investment in securities (like bonds) after taking into account the expected inflation rate. It is calculated by deducting inflation rate from the Nominal rate of interest.

Nominal Rate of Interest: It is the rate of which is specified on a particular security (like Bonds). In the case of bonds it is also known as the coupon interest rate. Thus it can be said that the nominate rate is the rate of interest which is advertised on the securities such as bonds and is not inflation adjusted.

Formula:

Real Rate of Interest = Nominal Rate of Interest – Expected inflation rate

Therefore,

Nominal Rate of Interest = Real Rate of Interest + Expected inflation rate

                                            = 4.20 % + 6.60 %

                                              = 10.80%

Thus the nominal rate of interest will be 10.80%