Question

If the nominal interest rate is 8 percent and expected inflation is 2.5 percent, then what is the real interest rate?
a.

20 percent
b.

5.5 percent
c.

10.5 percent
d.

3.2 percent

Answer 1

To calculate the real interest rate, you can use the Fisher equation, which is:

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

where:
- \( i \) is the nominal interest rate,
- \( r \) is the real interest rate, and
- \( \pi \) is the expected inflation rate.

For small values, you can also use the approximation:

\[
r \approx i - \pi
\]

Given:
- Nominal interest rate (\( i \)) = 8% or 0.08,
- Expected inflation (\( \pi \)) = 2.5% or 0.025.

Using the approximation:

\[
r \approx 0.08 - 0.025
\]
\[
r \approx 0.055 \text{ or } 5.5\%
\]

So the real interest rate is approximately \( 5.5\% \).

The correct answer is:
**b. 5.5 percent**