Question

1. a) If a dollar is always worth a dollar, why do people say the dollar has ‘lost its value’?

  b) Explain the real rate and nominal rate of interest? Which is more relevant?

Answer 1

(A) We say that the dollar has lost its value it means the dollar has lost its value against foreign currencies. It means dollar has depreciated against foreign currencies. The appreciation and depreciation of currency keeps happening due to the volume of trade between countries. If US's net exports(exports-imports) falls compared to its trading partners, then the dollar depreciates against foreign currency (lose value).

(B) Real interest rate is the interest rate adjusted for inflation. Whereas the nominal rate of interest is the absolute value of interest rate and it us not adjusted for inflation.

The relation between real interest rate, nominal interest rate and expected inflation rate is given below:

Real interest rate = Nominal interest rate - expected inflation rate.

It shows that an increase in the inflation rate, reduces the real interest rate.

The real interest rate is more relevant because it takes inflation into account. It shows how the inflation is decreasing or affecting our real interest rate.