Suppose that the nominal rate of interest is 5 percent and t

Suppose that the nominal rate of interest is 5 percent and the inflation premium is 1 percent.

What is the real interest rate? ____ %

Alternatively, assume that the real interest rate is 4 percent and the nominal interest rate is 6 percent.

What is the inflation premium? _____ %

Solution

1) To find the real interest rate,you have to subtract the inflation premium from the nominal interest rate.

so,Real interest rate = nominal interest rate - inflation premium

= 5% - 1%

= 4%

2) Also,inflation premium can be found by using the same equation above so that,

Inflation premium = nominal interest rate - real interest rate

= 6% - 4%

= 2%