EBK MACROECONOMICS (FOURTH EDITION)
4th Edition
ISBN: 9780393616125
Author: Jones
Publisher: YUZU
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Question
Chapter 8, Problem 9E
To determine
Calculate the nominal interest rate and the Fisher equation.
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Nelson, a management trainee at a large New York-based bank, is trying to estimate the real rate of return expected by investors. He notes that the 3-month T-bill currently yields 8 and has decided to use the consumer price index as a proxy for expected inflation, if the CPI is currently 2.5.
What is the estimated real rate of interest?
Lucy is tempted to buy 200 apples, with each one costing $2. However, she realizes that if she saves the money in a bank account she should be able to buy 240 apples. If the cost of the an apple increases by the rate of inflation, i.e. 8%, according to the Fisher equation, how much would the nominal rate (%) of the return on the bank account have to be?
Explain with calculations and conclusion
a)Suppose that on January 1, 2019 a bank lends $20,000 to a person. The bank and the individual both agree that the real interest rate charged on the loan should be 10% and the loan is going to be totally paid ($20,000 plus interest), in a one-time payment, on December 31, 2020. Suppose the two parties to this transaction can perfectly foresee what the inflation rate for this period is going to be.
b) Assume the same conditions exist as in the paragraph a but now the bank and the borrower cannot predict the inflation rate perfectly. Assume that both the bank and the borrower expect an inflation rate of 8% over this period of time. Given this information, what is the nominal rate charged on the loan now? Given the actual inflation rate (from your calculations and the provided data), who wins from this loan contract and who loses from this loan contract? Explain your answer fully. What if the expected inflation rate is 4% during this period? Does your answer change as to who wins and…
Chapter 8 Solutions
EBK MACROECONOMICS (FOURTH EDITION)
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- Suppose I lend my friend Peter $100 for one year, and he agrees to repay me with interest. We each have an expectation that the inflation rate over the coming year will be 5 percent, and so we agree that he will pay me back at a nominal rate of 7 percent interest. a) What real rate of return do I expect to receive? b) What happens if inflation turns out to be 8 percent over the year? Who is made better off and who is made worse off? c) What happens if inflation turns out to be 3 percent over the year? Who is made better off and who is made worse off?arrow_forwardSuppose the nominal interest rate is 0.64 and the expected inflation rate is 0.47 1) What is the exact real interest rate? 2) What is the approximate real interest rate?arrow_forwardDean borrows $400 from Tim. Tim wants to make a 7% real return on his money, so they both agree on a 7% stated interest rate paid next year. Dean and Tim did not anticipate any inflation, yet the actual inflation turned out to be 2% next year. In this case, what is Tim’s real rate of return?arrow_forward
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