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Date Posted: 09:01:32 03/06/02 Wed
Author: DR. D.
Subject: Real Rates, Nominal Rates, & Inflation
In reply to: Tim Thurber 's message, "Problem 7.4 and 7.5, Page 190" on 15:49:26 03/05/02 Tue

Tim:

The real rate is the rate after netting out the effect of inflation, or in other words, the rate in a world without inflation.

The rate you would require (in 7.4) is the NOMINAL rate (the rate in a world with inflation).

From the previous page, the equation tells us that:

1 + Nominal Rate = (1 + Real Rate) x (1 + Inflation)

so, plug in the numbers to get

1.04 x 1.08 = 1.1232 = 1 + Nominal Rate

Therefore, the Nominal rate = .1232 or 12.32%

In 7.5, you are solving for the real rate.

(1.08) = (1.05)(1+x)

so, X = 1.08/1.05 - 1, or 2.857%




>Dr. Dadalt,
>
>I'm not understanding how the book came to their
>answers for these two questions in the chapter. Could
>you quickly explain one of those two problems. I
>understand you are supposed to use the formula on the
>preceeding page, but I'm not coming up with their
>answer.
>
>Thanks,
>
>Tim Thurber

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