Question

Monetary approach and forecasting.

Suppose relative PPP and the quantity theory of money hold. Suppose you expect the rate of money growth of Argentina in the next year to be around 15% while your forecast for its real GDP growth is at 2%. Suppose inflation in Brazil is expected to be at 4%.
Suppose you learn that the government of Argentina is planning to cut taxes. You expect this tax cut to be financed through money creation and revise your forecast for money growth to be 25% instead of 15%.
Suppose that you also expect the UIP to hold. You know that the nominal interest rate in Brazil today is 6% (on deposits maturing in a year).
1. What is the nominal interest rate in Argentina?
2. What is the world real interest rate?

Answer 1

1. The nominal interest rate in Argentina is:

= 25%

2. The world real interest rate is:

= 2%.

Step-by-step explanation:

a) Data and Calculations:

Expected money growth rate of Argentina next year = 15%

Forecasted real GDP growth = 2%

Expected inflation rate = 13% (15% - 2%)

Nominal interest rate = real interest rate + inflation rate

Real interest rate = 25% - 13% = 12%

Nominal interest rate = 12% + 13% = 25%

The world real interest rate = nominal interest rate minus inflation rate

= 6% - 4% = 2%