If Treasury bills are currently paying 6.3 percent and the inflation rate is 1.7 percent, what is the approximate and the exact real rate of interest?

Given Information:

Nominal Interest Rate = 6.3 %

Inflation Rate = 1.7 %

Required Information:

approximate real rate of interest?

exact real rate of interest?

Answer:

approximate real rate of interest = 4.6%

exact real rate of interest = 4.5%

Explanation:

Nominal Interest Rate: The interest rate that a person earn or pay on a loan.

Real Interest Rate: The nominal interest rate after adjusting for inflation.

Relation between Nominal and Real Interest Rate: The fisher equation

Real Interest Rate = Nominal Interest Rate - Inflation Rate

approximate real rate of interest = 6.3% - 1.7% = 4.6%

exact real rate of interest = (1 + 0.063) / (1 + 0.017) = 1.045 = 4.5%