You loaned $100 to a friend for one year at a nominal rate of interest of 5 percent. Inflation during that year was 8 percent. How much did the purchasing power of your money change (an increase is positive and a decrease is negative)?
A) increase by around 3 percent.
B) decrease by around 3 percent.
C) increase by around 13 percent.
D) decrease by around 13 percent.

Question

Quizplus · Accepted Answer

Nominal interest rate refers to the stated interest rate without any adjustment for inflation. Inflation reduces the purchasing power of money over time. To calculate the real interest rate, we subtract the inflation rate from the nominal interest rate.

Real interest rate = Nominal interest rate - Inflation rate
Real interest rate = 5% - 8% = -3%

Since the real interest rate is negative, it means that the purchasing power of your money decreased by around 3 percent. Therefore, the correct answer is B.

You Loaned $100 to a Friend for One Year at a Nominal