Question

If the nominal interest rate is 6 percent and the rate of inflation is 2 percent, then what is the real interest rate?

1) 4 percent
2) 2 percent
3) 8 percent
4) 10 percent

Answer 1

The real interest rate is found by subtracting the rate of inflation from the nominal interest rate. In the scenario with a nominal interest rate of 6 percent and inflation at 2 percent, the real interest rate would be 4 percent.

Step-by-step explanation:

To calculate the real interest rate, you subtract the rate of inflation from the nominal interest rate. Given a nominal interest rate of 6 percent and an inflation rate of 2 percent, you can determine the real interest rate as follows:

1. Start with the nominal interest rate: 6%
2. Subtract the rate of inflation: 2%
3. The resulting real interest rate: 6% - 2% = 4%

Therefore, the real interest rate in this scenario is 4 percent.

This calculation is important because, in economics, the real interest rate more accurately reflects the true cost of borrowing and the real yield on savings, once inflation has been taken into account. For example, if the nominal interest rate is 7% and the rate of inflation is 3%, then the borrower is effectively paying a 4% real interest rate. However, if there is deflation of 2%, the real interest rate becomes 9%, increasing the cost for borrowers.

The transformation of a nominal interest rate into a real interest rate can have important economic implications, especially when considering the effect of taxes. A taxpayer who receives interest income is taxed on the nominal gain, not the real gain. This can result in paying taxes even when the real purchasing power has not increased, or in the case of negative real interest rates, has actually decreased.