Question

Nominal Interest Rate =__________

• A. Real Interest Rate × Inflation Rate
• B. Real Interest Rate – Inflation Rate
• C. Real Interest Rate / Inflation Rate
• D. Real Interest Rate + Inflation Rate

Answer 1

The Correct Option is D

To determine the nominal interest rate, we apply the Fisher equation, which is a fundamental concept in economics. The Fisher equation states that the nominal interest rate is the sum of the real interest rate and the inflation rate. This relationship can be expressed with the following formula:

Nominal Interest Rate = Real Interest Rate + Inflation Rate 

Explanation:

• Real Interest Rate: This is the interest rate that has been adjusted for inflation, reflecting the true cost of borrowing or the true yield on savings.
• Inflation Rate: This is the rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling.
• Nominal Interest Rate: This is the interest rate before adjustment for inflation. It represents the rate of interest that is usually quoted by financial institutions.

In summary, the nominal interest rate is calculated by adding the real interest rate to the inflation rate. Therefore, the correct formula is:

Nominal Interest Rate = Real Interest Rate + Inflation Rate

Answer 2

According to the Fisher equation, the nominal interest rate is the sum of the real interest rate and the inflation rate. The equation is commonly expressed as:

\( i = r + \pi \)

Where:

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

The nominal interest rate is the interest rate that is observed in the market, without adjusting for inflation. The real interest rate, on the other hand, represents the rate of return on an investment after accounting for the effect of inflation. The inflation rate reflects the percentage change in the price level of goods and services over time.

The Fisher equation is crucial for understanding the relationship between these rates. It shows that when inflation rises, the nominal interest rate tends to increase as well to maintain the same real return for investors. This equation is widely used in finance and economics to analyze interest rates and the effects of inflation on investment and borrowing.