Question

suppose that lenders want to receive a real rate of interest of 5%, and that they expect inflation to remain steady at 3% in the coming years. based on this, lenders should charge a nominal interest rate of

Answer 1

The interest rate is 7%.

Solution:

The real rate of interest is always above the nominal interest rate when inflation is positive. In this case, we are told inflation is 3%. Since the real rate of return is the nominal interest rate minus inflation, we need a nominal interest rate of 5%+3%=8% to get a real interest rate of 5%.

To calculate the real interest rate subtract the inflation rate from the nominal interest rate. Mathematically it looks like this The real interest rate is the nominal interest rate minus the inflation rate. Creeping inflation is a type of inflation in which the price level rises steadily at a moderate rate over an extended period of time.

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