Chapter 29, Problem 2MCQ

To determine

Formula of real interest rate

Explanation of Solution

When calculating the nominal interest rate, the interest rate is multiplied by the anticipated inflation rate. Simply explained, this rate gives information about the real rate of return that a lender or investor would experience after inflation takes hold. While the real inflation fee is either unknown or anticipated, this type of fee is considered predictive. The Fisher effect is used to obtain the following equation. An economic theory that hobby quotations rise or decrease in direct proportion to changes in inflation was developed by economist Irving Fisher in the 1930s.

This means that if inflation increases, the real interest rate—the rate of return earned by lenders and borrowers—will decrease until it catches up with inflation.

The nominal interest rate less the inflation rate is the real interest rate.

Thus, the correct option is B.