3. falls to 2.5% rises to 5.5% remains at 3.5% rises to 4.5% 4. rises to remains

Question

3. falls to 2.5%

rises to 5.5%

remains at 3.5%

rises to 4.5%

4. rises to

remains at

falls to

5. 2%

1%

0.5%

4.5%

6. below

above

the same as

Suppose expected inflation is 3.5% in the United States and 296 in Germany. The nominal interest rate in the United States is 4.5%. Assume that purchasing power parity (PPP) and uncovered interest parity (UIP) hold. What is the nominal interest rate in Germany? o 4.5% o 8% o 3.5% 2% 3% What is the expected real interest rate in Germany? O 0.5% 3% O 1% 0 2.5% o 4.5% Now suppose the nominal interest rate in the United States rises to 5.5%, while nothing changes in Germany. This implies that the expected inflation rate in the United States United States , and the real interest rate in the Germany's real interest rate.

Explanation / Answer

Now suppose the nominal interest rate in the United States rises to 5.5%, while nothing changes in Germany. This implies that the expected inflation rate in the United States remains at 3.5%, and the real interest rate in the United States rises to 2%, which is above Germany's real interest rate.

Real interest rate = Nominal interest rate - Expected inflation rate

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