Question

If the nominal interest rate is 4.00% and the rate of inflation is 2.25%, what is the real interest rate?

1.75%
4.50%
6.25%
9.00%

Answer 1

To find the real interest rate, you can use the Fisher equation, which states that:

\[
1 + r = \frac{1 + i}{1 + \pi}
\]

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

In this case, the nominal interest rate (\( i \)) is 4.00% or 0.04, and the rate of inflation (\( \pi \)) is 2.25% or 0.0225.

Using the Fisher equation, we can calculate the real interest rate as follows:

\[
1 + r = \frac{1 + 0.04}{1 + 0.0225}
\]

Calculating the values:

\[
1 + r = \frac{1.04}{1.0225} \approx 1.0173
\]

Subtracting 1 from both sides to solve for \( r \):

\[
r \approx 1.0173 - 1 \approx 0.0173
\]

Converting to a percentage:

\[
r \approx 1.73\%
\]

So the closest answer from the choices provided is **1.75%**.