Question

Banks often estimate inflation. You can see what they think inflation will be if you know how much they charge for loans and how much they expect to earn. Suppose the nominal interest rate is 7% and the real interest rate is 2%. Given these interest rates, the bank thinks inflation will be_________ %

Answer 1

5%

Step-by-step explanation:

To find the answer, we use the Nominal Interest Rate formula:

Nominal Interest Rate = Real Interest Rate + Inflation Rate

Now, we plug the amounts into the formula, and confirm that the answer is correct:

7% = 2% + 5%

As we can see, the nominal interest rate is the sum of the real interest rate and the inflation rate. Therefore, banks will estimate the nominal interest rate taking into account the expected inflation rate.