Assume that the nominal interest rate is 11 percent, the inflation rate is 8 percent, and government debt at the beginning of the year equals $4 trillion. By how much is the government budget deficit overstated as a result of inflation?
A) $0.12 trillion
B) $0.32 trillion
C) $0.44 trillion
D) $0.80 trillion

Question

Quizplus · Accepted Answer

The government budget deficit is overstated due to the inflation component of the nominal interest rate. The real interest cost on the debt is the nominal interest rate minus the inflation rate. In this case, 11% - 8% = 3%. The overstatement is due to the 8% inflation on the $4 trillion debt, which equals 0.08 * $4 trillion = $0.32 trillion.

Assume That the Nominal Interest Rate Is 11 Percent, the Inflation