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 6 percent.The nominal interest rate is
A) 3 percent.
B) 4 percent.
C) 5 percent.
D) 10 percent.
E) 6 percent.

Question

Quizplus · Accepted Answer

The Fisher equation gives the relationship between the nominal interest rate, real interest rate, and expected inflation rate as:

nominal interest rate = real interest rate + expected inflation rate

In this scenario, we know that the real interest rate is 3 percent, and the quantity of money is growing at 6 percent. Assuming that velocity remains constant, the expected inflation rate will be:

expected inflation rate = growth rate of money supply - growth rate of real GDP
expected inflation rate = 6% - 4% = 2%

Using the Fisher equation, we can find the nominal interest rate:

nominal interest rate = real interest rate + expected inflation rate
nominal interest rate = 3% + 2%
nominal interest rate = 5%

Therefore, the nominal interest rate is 5 percent.

In the Long Run, the Real Interest Rate Is 3