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PART TEN
MONEY AND PRICES IN THE LONG RUN
For example, if the bank posts a nominal interest rate of 7 percent per year and the
inflation rate is 3 percent per year, then the real value of the deposits grows by 4
percent per year.
We can rewrite this equation to show that the nominal interest rate is the sum
of the real interest rate and the inflation rate:
Nominal interest rate
±
Real interest rate
²
Inflation rate.
This way of looking at the nominal interest rate is useful because different eco
nomic forces determine each of the two terms on the righthand side of this equa
tion. As we discussed in Chapter 25, the supply and demand for loanable funds
determine the real interest rate. And, according to the quantity theory of money,
growth in the money supply determines the inflation rate.
Let’s now consider how the growth in the money supply affects interest rates.
In the long run over which money is neutral, a change in money growth should
not affect the real interest rate. The real interest rate is, after all, a real variable. For
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 Spring '10
 abijian

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