Question

If interest rate parity holds and the annual German nominal interest rate is 3 percent and the U.S. annual nominal rate is 5 percent and real interest rates are 2 percent in both countries, then inflation in Germany is about _______________ than in the United States.

A) 2 percent higher
B) 2 percent lower
C) 1 percent higher
D) 1 percent lower
E) 4 percent lower

Answer 1

B) 2percent lower

Step-by-step explanation:

Nominal interest rate = Real interest rate + inflation rate

Inflation rate = Nominal interest rate- real interest rate.

For Germany:

Given

Nominal rate = 3%

Real interest rate= 2%

Inflation rate = 3%-2%

Inflation rate for Germany = 1%

For United State:

Nominal interest rate = 5%

Real interest rate = 2% (same as for Germany)

Inflation rate = 5%-2%

Inflation rate for US = 3%.

The inflation rate in US is therefore 2% higher than that of Germany OR the inflation rate in Germany is about 2% lower than that of the United States.

Answer 2

B) 2 percent lower

Step-by-step explanation:

Norminal interest rate is an economic terminology used to describe the interest rate of an economy before considering or adjusting the impact of Inflation on the economy.

Real interest rate is the interest rate of an economy obtained after adjusting the impact or effects of the Inflation. This will reveal the actual cost of borrowing and the yield to the lender of the money.