In the long run, the real interest rate is 3 percent, real GDP grows at 4 percent, velocity is constant, and the quantity of money grows at 8 percent.The nominal interest rate is
A) 6 percent.
B) 7 percent.
C) 8 percent.
D) 10 percent.
E) 12 percent.

Question

Quizplus · Accepted Answer

The Fisher equation states that nominal interest rate equals the sum of real interest rate and expected inflation. Therefore, 
Nominal interest rate = real interest rate + expected inflation
Expected inflation = (growth rate of money supply) - (growth rate of real GDP)
Expected inflation = 8% - 4% = 4%
Nominal interest rate = 3% + 4% = 7%.
Therefore, the answer is B, 7 percent.

In the Long Run, the Real Interest Rate Is 3