Question

Inflation — Quick Quiz Problem "An economy with constant velocity of money has real GDP growth of" 3%, money growth of 7%, and a real interest rate of 2%. What is the nominal interest rate?

Answer 1

Given Information:

Real GDP growth = Y = 3%

Money growth = M= 7%

Real interest rate = r = 2%

Velocity = constant = 0%

Required Information:

Nominal interest rate = ?

Answer:

Nominal interest Rate =  6%

Explanation:

The quantity theory of money (QTM) equation is given by

ΔM + ΔV = ΔP + ΔY

ΔP = ΔM + ΔV – ΔY

Substituting the percentages given in the problem,

ΔP = ΔM + ΔV – ΔY

ΔP = 7% + 0% – 3%

ΔP = 4%

The fisher equation which relates real and nominal interest rate is given by

Real interest rate = Nominal interest rate - Inflation rate

Re-arranging the equation to find nominal interest

Nominal interest rate = Real interest rate + Inflation rate

Nominal interest rate =  2% + 4%

Nominal interest Rate =  6%