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Interest Rate, Inflation, Money Market
2 Real vs Nominal Interest Rates
1. Tywin knows he has a debt to repay soon. The bank charges him an interest rate of
6%, percent. If the expected rate of inflation is 5%, how much interest is he effectively
paying? Explain.
2. Calculate the nominal rate of inflation that will be charged if the expected rate of
inflation is 7%, and the real return desired is 5%. Show all work.
3. If the rate of inflation is 3% instead, what happens to the value of the money paid
back? Explain.
i = r + infe = 7% + 5% = 12%
If the actual rate of inflation turns out to be 3%, then the real interest earned from a
nominal interest rate of 12% is:
r = i − inf = 12% − 3% = 9%
In this case, because the inflation was lower than expected, the real amount paid back
(9%) is higher than the real amount that was anticipated (7%). Lenders benefits from this
unanticipated disinflation and borrowers are hurt.
4. The real interest rate paid on an asset was 10%, but the nominal rate was 9%. What
was the rate of inflation?
You may find the above answers in this link, you should read the article to
understand:
https://www.khanacademy.org/economics-financedomain/macroeconomics/monetary-system-topic/macro-financial-assets/a/lessonsummary-financial-assets
5 The Money Market
3. Show the impact of inflation on interest rates using the money market. Explain why
the change that you showed occurs.
You may find the answer in this link: Please add the graph with explaintion.
https://www.khanacademy.org/economics-financedomain/macroeconomics/monetary-system-topic/macro-the-money-market/a/the-moneymarket
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