Question

If nominal interest rate equals 5 percent and expected inflation is 3 percent, then the new nominal and real interest rates are respectively: 3% and 5%. 8% and 5%. 5% and 2%. 5% and 7%. 7% and 5%.

Answer 1

Answer:

If nominal interest rate equals 5 percent and expected inflation is 3 percent, then the new nominal and real interest rates are respectively 5% and 2%.

Explanation:

The nominal interest rate is called the interest rate that is set by the bank and that will be added to the initial capital gradually according to the percentage established in the initially determined time. Thus, in the case, an annual interest of 5% is given, with which a deposit of $ 100 will rise to $ 105 after one year.

Now, the nominal interest rate may not represent real money growth. This is so because, due to inflation, a depreciation of the invested value occurs. Thus, for example, a deposit with an interest rate of 5% per year in a currency with inflation of 10% per year is losing 5% of its value during that year. In the case, since inflation is 3%, the real interest rate (that is, the real growth of investment) is 2%.