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26 June, 23:33

Inflation - Quick Quiz Problem "An economy with constant velocity of money has real GDP growth of" 3%, money growth of 7%, and a real interest rate of 2%. What is the nominal interest rate?

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  1. 26 June, 23:55
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    Given Information:

    Real GDP growth = Y = 3%

    Money growth = M = 7%

    Real interest rate = r = 2%

    Velocity = constant = 0%

    Required Information:

    Nominal interest rate = ?

    Answer:

    Nominal interest Rate = 6%

    Explanation:

    The quantity theory of money (QTM) equation is given by

    ΔM + ΔV = ΔP + ΔY

    ΔP = ΔM + ΔV - ΔY

    Substituting the percentages given in the problem,

    ΔP = ΔM + ΔV - ΔY

    ΔP = 7% + 0% - 3%

    ΔP = 4%

    The fisher equation which relates real and nominal interest rate is given by

    Real interest rate = Nominal interest rate - Inflation rate

    Re-arranging the equation to find nominal interest

    Nominal interest rate = Real interest rate + Inflation rate

    Nominal interest rate = 2% + 4%

    Nominal interest Rate = 6%
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