Question

The real interest rate is 4 percent and the nominal interest rate is 6 percent. Is there inflation or deflation? What is the inflation or deflation rate?
a.

inflation; 10 percent
b.

deflation; 10 percent
c.

inflation; 2 percent
d.

deflation; 2 percent

Answer 1

The relationship between nominal interest rates, real interest rates, and the inflation rate can be expressed by the Fisher equation:

\[
1 + i = (1 + r)(1 + \pi)
\]

Where:
- \( i \) is the nominal interest rate
- \( r \) is the real interest rate
- \( \pi \) is the inflation rate

In this case:
- \( i = 6\% \) or 0.06
- \( r = 4\% \) or 0.04

Using a simpler approximation for small rates, we can use:

\[
\pi \approx i - r
\]

So:

\[
\pi \approx 0.06 - 0.04 = 0.02 \text{ or } 2\%
\]

This indicates that there is inflation of 2 percent.

Thus, the correct answer is:
**c. inflation; 2 percent**.