Chapter 29, Problem 7MCQ

To determine

Effect on nominal interest rate on changing the inflation rate.

Explanation of Solution

The nominal interest rate is the alternative of the actual interest rate and the powerful interest rate. Real interest prices are typically essential to buyers and lenders, at the same time as powerful hobby prices are essential to each debtor and buyers and lenders.

The nominal interest rate is the agreed-upon interest rate associated with the loan, but not the interest rate that consumers typically pay. Rather, clients pay a powerful fee that varies primarily based totally on charges and compounding effects. The Annual Rate of Return (APR) differs from the nominal interest rate because it takes into account fees, while the Annual Yield (APY) takes into account both fees and compound interest. The nominal interest rate does now no longer take inflation into account, however, the actual interest rate does.

The CPI is used to calculate the real interest rate, which is calculated as the nominal interest rate less the inflation rate (Consumer Price Index).

As a result, the nominal interest rate rose less than the rate of inflation did. Hence, the correct option is C.

Economics Concept Introduction

Introduction:

How do banks determine the interest rate they charge? There are two important points to consider:

How much interest is enough for a bank to be worth lending money (the real interest rate they get)? How much of the purchasing power of interest rates can be lost to inflation?

Suppose the bank wants him to earn 10% interest but assumes that there is 3% inflation. If you don't include this inflation in the interest rate change, then effectively he earns only 7% (because he loses his 3% of the purchasing power of the 10% interest rate). Instead, banks factor inflation into interest rates. Taking inflation into account, this bank charges 13% interest.