Chapter 4, Problem 25AP

To determine

The nominal interest rate that a bank will charge when expected annual inflation over the life of bond is 1% and when the actual inflation is 0.5%.

Given:

For a loan that you want to take from a local bank, the annual interest rate charged by the bank is 3%.

Concept Introduction:

For a loan, the amount of money, to be paid as interest that is in the monetary form is called the nominal interest. While for servicing the debt payment, the extra output that is to be generated is the real interest rate.

The rate at which the value of currency declines is the inflation.

Real interest rate = Nominal interest rate - Inflation.