Marge is lending Martin $1,000 for one year. The CPI is 1.60 at the time the loan is made. They expect it to be 1.76 in one year. If Marge and Martin agree that Marge should earn a 3 percent real return for the year, the nominal interest rate on this loan should be ________ percent.
A)3
B)7
C)13
D)16

Question

Marge is lending Martin $1,000 for one year. The CPI is 1.60 at the time the loan is made. They expect it to be 1.76 in one year. If Marge and Martin agree that Marge should earn a 3 percent real return for the year, the nominal interest rate on this loan should be ________ percent.
A)3
B)7
C)13
D)16

Quizplus · Accepted Answer

The inflation rate is expected to be 10 percent: (1.76 - 1.60)/ 1.6 = 0.10 or 10 percent. To achieve a real return of 3 percent, the nominal rate has to be 3 percent higher than the inflation rate, or 10 percent + 3 percent = 13 percent.

Marge Is Lending Martin $1,000 for One Year