Question

10. If the nominal interest rate is 7 percent and expected inflation is 4.5 percent, then what is the expected real interest rate?
A. 11.5 percent
B. 7.0 percent
C. 4.5 percent
D. 2.5 percent
E. less than 2.5 percent

11. Which of the following statements is (are) correct?
(x) In the U.S., from the early 1980s through the early 1990s, both inflation and nominal interest rates fell.
(y) If a country had deflation, the nominal interest rate would be less than the real interest rate.
(z) For a given real interest rate an increase in inflation makes the after-tax real interest rate decrease, which discourages savings.
A. (x), (y) and (z)
B. (x) and (y) only
C. (x) and (z) only
D. (y) and (z) only
E. (x) only

12. Gerald took out a fixed-interest-rate loan when the CPI was 200. He expected the CPI to increase to 206 but it actually increased to 204. The real interest rate he paid is
A. higher than he had expected, and the real value of the loan is lower than he had expected.
B. higher than he had expected, and the real value of the loan is higher than he had expected.
C. lower than he had expected, and the real value of the loan is higher than he had expected.
D. lower then he had expected, and the real value of the loan is lower than he had expected.
E. lower then he had expected, and the real value of the loan is the same as he had expected

Answer 1

Q1) Option (D), i.e., 2.5 percent is the right answer.

Q2) Option (D),i.e., y and z are correct according to the facts and figures present.

Q3) Option (A) seems correct as inflation and interest rates have inverse correlation. Lower rise in CPI than expected will tend to lower decrease in the Interest rates than expected, and thus higher Interest rates than expected.