Question 1

Which of the following best describes the difference between the nominal interest rate and the real interest rate, as shown in the graph?

Accepted Answer

The real interest rate is the nominal interest rate adjusted for inflation.

Question 2

According to the graph, during which period did the gap between the nominal and real interest rates appear to be the largest?

Accepted Answer

1975-1985

Question 3

If the nominal interest rate is 10% and the inflation rate is 7%, what is the real interest rate? Use the formula $$r^* = i - \pi.$$

Accepted Answer

$$3\%$$

Question 4

Based on the graph, what can you infer about the real interest rate during the late 1970s and early 1980s?

Accepted Answer

It was highly volatile and sometimes negative.

Question 5

Suppose the nominal interest rate is 5% and expected inflation is 6%. What is the expected real interest rate? Use the formula $$r = i - \pi^e.$$

Accepted Answer

$$-1\%$$

Question 6

Why is it important for borrowers and lenders to consider the real interest rate rather than just the nominal interest rate?

Accepted Answer

Because the real interest rate reflects the true increase in purchasing power after accounting for inflation.

Question 7

If inflation unexpectedly rises after a loan agreement is made, who benefits?

Accepted Answer

The borrower, because they repay the loan with money that is worth less.

Question 8

Given the formula for annualized inflation: $$x = \left(1 + \frac{\pi}{100}\$$right)^{1/12}$$ - 1$$, if annual inflation is $$4\%$$, what is the approximate monthly inflation rate?

Accepted Answer

$$0.33\% ($$using compounding)

Question 9

Which of the following statements is supported by the graph?

Accepted Answer

Nominal interest rates are generally higher than real interest rates.

Question 10

If the nominal interest rate is $$8\%$$ and the inflation rate is $$10\%$$, what is the real interest rate? Use $$r^* = i - \pi.$$

Accepted Answer

$$-2\%$$

Question 11

Why might real interest rates become negative, as seen in some periods on the graph?

Accepted Answer

Because inflation exceeds nominal interest rates.

Question 12

If a government bond offers a nominal interest rate of $$3\%$$ and expected inflation is $$4\%$$, what is the expected real return for the investor?

Accepted Answer

$$-1\%$$

Question 13

Which of the following best explains why nominal interest rates and real interest rates tend to move together over time?

Accepted Answer

Because changes in inflation expectations affect both rates.

Question 14

Suppose the nominal interest rate is $$6\%$$ and inflation is $$2\%. If $$inflation rises to $$5\%$$ but the nominal rate stays the same, what happens to the real interest rate?

Accepted Answer

It decreases from $$4\% to$$ $$1\%.$$

Question 15

If the real interest rate is negative, what does this imply for savers?

Accepted Answer

Their purchasing power decreases over time.

Inflation and Interest Rates: Concepts, Measurement, and Canadian Trends

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