In 2006 the inflation rate is 1 percent and Wally is willing to lend Barbara $100,000 at a 6 percent interest rate. In 2007, the inflation rate rises to 3 percent. As a result
A) Wally and Barbara will agree to a real interest rate of 9 percent.
B) Wally and Barbara will agree to a nominal interest rate of 5 percent.
C) Wally and Barbara will agree to a nominal interest rate of 8 percent.
D) Wally and Barbara will agree to a nominal interest rate of 9 percent.

Question

Quizplus · Accepted Answer

The nominal interest rate is the sum of the real interest rate and the inflation rate. Initially, the real interest rate was 5% (6% nominal - 1% inflation). With inflation rising to 3%, to maintain the same real interest rate, the nominal rate should be 8% (5% real + 3% inflation).

In 2006 the Inflation Rate Is 1 Percent and Wally