2011 - Econ21.18.2010 TrackingtheEconomy

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Econ 2 1.18.2010 Tracking the Economy Rise and fall in CPI (consumer price index) is inflation or deflation Producer price index inflation or deflation eventually effects the  consumer Real and nominal interest rates The real and nominal distinction is always the same: o Nominal: in terms of current dollars o Real: in terms of goods What interest rate to charge? Interest rates Loaning money today entails: o Forging buying a good today o Buying a good tomorrow when paid back To delay your consumption today, need to get a return o Even with  no inflation you would want to get back more than you  loaned Your return should be specified in real term Real and nominal interest rates Suppose expect inflation to be 5% this year Load $1 at 5% interest for a year Get back 1.05 at the end of the year
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o But 1.05 does not allow you to buy more stuff So… Lets suppose you want a 3 real return o Meaning you want to consume 3% more goods o Later we will see where this number comes from That is to give up 1 unit… Let r designate the net real return o R=.03 Having an informed guess for pi^e o Pi=inflation e=expected o How should we determine I, the nominal interest rate
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2011 - Econ21.18.2010 TrackingtheEconomy

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