If the inflation rate was 3.20% and the nominal interest rate was 4.20% over the last year, what was the real rate of interest over the last year? Disregard cross-product terms; that is, if averaging is required, use the arithmetic average. Round intermediate calculations to four decimal places.

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3 July, 07:36

If the inflation rate was 3.20% and the nominal interest rate was 4.20% over the last year, what was the real rate of interest over the last year? Disregard cross-product terms; that is, if averaging is required, use the arithmetic average. Round intermediate calculations to four decimal places.

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Troy Henderson · Answer 1

real interest rate = 1%

Explanation:

Inflation is the increase in the price level. It erodes the value of money.

Nominal interest is that quoted for investment or loan transactions. It has not been been adjusted for inflation.

Real interest rate is the amount of interest in terms of the the quantity of good and services that can be purchased. It is the nominal interest rate adjusted for inflation.

The relationship between inflation, real interest and nominal interest rate is given using the Fishers Effect;

(1+N) = (1+R) * (1+F))

N - nominal rate, R-real rate, F - inflation

r = (1+N) / (1+F) - 1

r = (1.042) / (1.032) - 1

r = 0.009689922 * 100

r = 1%