There is persistent fear that there will be a high level of deflation. Many econ
ID: 1192220 • Letter: T
Question
There is persistent fear that there will be a high level of deflation. Many economists warn that it may be worse for the economy than if there is high inflation. Let's work through one example. Suppose that Herb is in debt and has to pay a 5.00% nominal interest rate. He expected inflation to be 3.00%. Instead, inflation is -2.00% (deflation). 1.What is the real interest rate that Herb expected to pay? Write your number out to 2 decimal places (for example, 1.11, not just 1) 2.What is the real interest rate that Herb will in fact pay? Write your number out to 2 decimal places (for example, 1.11, not just 1)
Explanation / Answer
Real interest rate = Nominal Interest rate - Inflation rate
(1)
Expected real interest rate = Nominal interest rate - Expected inflation rate
= 5.00% - 3.00%
= 2.00%
(2)
Actual real interest rate = Nominal interest rate - Actual inflation rate
= 5.00% - (- 2.00%)
= 5.00% + 2.00%
= 7.00%
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.