Question

If Treasury bills are currently paying 6.5 percent and the inflation rate is 1.3 percent, what is the approximate and the exact real rate of interest

Answer 1

the approximate real interest rate = nominal rate - inflation rate = 6.5% - 1.3% = 5.2%

the exact real interest rate is calculated using the following formula:

(1 + nominal interest rate) = (1 + real interest rate) (1 + expected rate of inflation)

(1 + 0.065) = (1 + real interest rate) x (1 + 0.013)

1 + real interest rate = (1 + 0.065) / (1 + 0.013) = 1.065 / 1.013 = 1.05133

real interest rate = 1.05133 - 1 = 0.05133 = 5.13%