Quiz 8 Examples

# Quiz 8 Examples - Quiz 8 Examples 1. If the nominal rate of...

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Quiz 8 Examples 1. If the nominal rate of interest is 3% and the expected rate of inflation is 5%, what is the real rate of interest? The R = R N – P*, where R is the real interest rate R N is the nominal interest rate and P* is the rate of inflation. In this case R = 3% - 5% = - 2%, which is negative. The real interest can be negative. Barring very unusual circumstances, the nominal interest rate must be non-negative. 2. If the nominal rate of interest is 6%, the expected rate of growth of real GDP is 1%, and the expected rate of growth of nominal GDP is 4%, then what is the real rate of interest? This is like the first example, except you are not told the expected rate of inflation and must calculate it instead. The way to calculate it is to note that (PY)* = P* + Y*, where (PY)* is the rate of growth of nominal GDP, Y* is the rate of growth of real GDP, and P* is the rate of inflation. This is an approximation that fits reasonably well at low rates of inflation and growth. P* = (PY)* - Y* = 4% - 1% = 3%.

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## This note was uploaded on 02/17/2012 for the course ECO 2013 taught by Professor Denslow during the Fall '05 term at University of Florida.

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Quiz 8 Examples - Quiz 8 Examples 1. If the nominal rate of...

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