Question 1

Based on the graph provided, which of the following statements best describes the relationship between nominal and real interest rates from 1955 to 2018?

Accepted Answer

The nominal interest rate generally exceeds the real interest rate, and the gap between them tends to widen during periods of high inflation.

Question 2

Suppose in 1981, the nominal interest rate peaked at approximately 18% per year, while the real interest rate was about 8% per year. What was the approximate inflation rate at that time?

Accepted Answer

$$18\% - 8\% = 10\%$$ inflation rate

Question 3

During which period did the real interest rate become negative according to the graph, and what does this imply for savers?

Accepted Answer

Around 1975 and again after 2008; this implies that the purchasing power of savings decreased over time.

Question 4

If the nominal interest rate is 5% and the inflation rate is 6%, what is the real interest rate?

Accepted Answer

$$5\% - 6\% = -1\%$$

Question 5

Which of the following best explains why the gap between nominal and real interest rates widened in the late 1970s and early 1980s?

Accepted Answer

There was a significant increase in inflation, which increased the difference between nominal and real rates.

Question 6

If a lender wants to ensure a real return of 3% and expects inflation to be 2%, what nominal interest rate should they charge?

Accepted Answer

$$3\% + 2\% = 5\%$$

Question 7

Which of the following scenarios would most likely result in a negative real interest rate?

Accepted Answer

The inflation rate is higher than the nominal interest rate.

Question 8

If the expected inflation rate is 4% and the nominal interest rate is 6%, what is the expected real interest rate?

Accepted Answer

$$6\% - 4\% = 2\%$$

Question 9

Why is it important for borrowers and lenders to consider expected inflation when agreeing on an interest rate?

Accepted Answer

Because the real value of repayments depends on the actual inflation rate, not just the nominal rate.

Question 10

Suppose the nominal interest rate is 7% and the inflation rate unexpectedly rises from 2% to 5%. What happens to the real interest rate, and who benefits?

Accepted Answer

The real interest rate falls from $$7\% - 2\% = 5\% to$$ $$7\% - 5\% = 2\%$$, benefiting borrowers.

Inflation and Interest Rates: Measurement, Effects, and Macroeconomic Implications

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