Macro Topic 4.

2
Nominal v. Real Interest Rates
Part 1 - Practice​-​ Answer the questions regarding nominal interest rate and real interest rate.

Answer

1. Assume the nominal interest rate was 5% and inflation was 3%. What was 2%
8%
the real interest rate?

2. Assume the real interest rate was -2% and the inflation rate was 8%. What 6%
was the nominal interest rate? 6%

3. Assume the real interest rate was 4% and the nominal interest rate was 6%. 2%
2%
What was the expected rate of inflation?

4. Assume the nominal interest rate was 4% and the rate of inflation was 7%. -3%
-3%
What was the real interest rate?

5. Assume the real interest rate was 7% and the nominal interest rate was 3%. -4%
-4%
What was the inflation rate?

6. Assume the real interest rate is 3% and the inflation rate was 8%. What was 11%
11%
the nominal interest rate?

Part 2 – Check Your Understanding​-​ Answer the following questions.

7. Explain why the real interest rate can only be calculated in hindsight.
The real interest-rate can only be calculated in hindsight because it Hass to take into consideration the nominal interest rate less the inflation rate.

8. Assume that when the expected inflation rate was 2%, the nominal interest rate was 5%. Suppose
that the expected inflation rate increased to 4%, all other things equal, predict the new nominal
interest rate. Explain your reasoning.
7%, they move together

9. Assume that the expected inflation rate was 2% and the nominal interest was 5%. However, actual
inflation turns out to be 4%. Who is benefited by this higher-than-expected inflation? Explain your
reasoning. borrowers benifit as they have to pay less

10. Suppose that the expected inflation rate was 2% and the nominal interest rate was 5% and actual
inflation turns out to be to be -3%. Who is benefited by this lower-than-expected inflation? Explain
your reasoning.
Lenders, there is more purchasing power

11. Explain why prolonged periods of deflation can be particularly burdensome for people who are in
debt.

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 Macro Topic 4.2
Nominal v. Real Interest Rates
Part 3 – Making Connections​-​ The table below shows the price index and nominal interest rate for
the US between 1929 and 1933. Fill in the blanks on the table below then answer the questions.

Year Price Index Inflation Rate Nominal Interest Rate Real Interest Rate

1929 13.12 -1.15% 5.85% 7.00%

1930 12.60 -3.96% 3.59% 7.87%

2.55

1931 11.34 -10.0% 2.64% 14.04%

4.6%

1932 10.05 -11.38%

-11.38 2.73% 15.92%
14.11

1933 9.78 -2.69

-2.96% 1.73% 4.54%
4.62

12. Given that farming is a seasonal profession where farmers borrow money and pay it back after
crops are harvested, predict what likely happened to farmers between 1929 to 1932. Explain your
reasoning.

13. Based on the table above, what likely happened to the prices of crops for farmers between 1929
and 1932? Explain your reasoning.

14. Considering your answers above, explain why farmers faced some of the most significant
challenges during the Great Depression.

15. Explain why a little deflation puts downward pressure on prices and often leads to even more
deflation.

Part 4 – Stretch Your Thinking​-​ Read the quote and answer the questions.
“True individual freedom cannot exist without economic security and independence.
People who are hungry and out of a job are the stuff of which dictatorships are made.”
- Franklin D. Roosevelt, US President 1933-1945
16. Why might farming be one of the most important industries in maintaining economic stability?

17. Research the Agricultural Adjustment Act (AAA) passed in 1933. Did President ​Roosevelt seek to
influence crop prices or interest rates?

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