Question

Currently, the price index used to calculate the inflation rate is equal to 90. The general expectation throughout the economy is that next year its value will be 99. The current nominal interest rate is 12 per cent. What is the real interest rate?

Short answer

The real interest rate is$2\%$

Step-by-step solution

introduction

The expected inflation for the following year is found by

$$\begin{gathered} \Rightarrow \frac{PriceIndexofnextyear-PriceIndexofcurrentyear}{PriceIndexofcurrentyear}\times 100 \\ =\frac{99-90}{90}\times 100 \\ =10\% \end{gathered}$$

explanation

Now ,

real interest rate = nominal interest rate - expected inflation

$$\begin{gathered} \Rightarrow 12\%-10\% \\ =2\% \end{gathered}$$

The real interest rate is$2\%$.