We can write the true relationship between the nominal interest rate and the real rate and expected inflation as ________.
A)(1 + r)= (1 + r)× (1 + h*)
B)r = (1 + r*)× (1 + h)- 1
C)r* = (1 + r)× (1 + h)-1
D)r = (1 + r*)× (1 + h)+ 1

Question

Quizplus · Accepted Answer

The correct formula that relates the nominal interest rate (r), the real rate (r*), and the expected inflation rate (h) is given by equation B, which expresses the nominal rate as the sum of the real rate and the expected inflation rate after adjusting for compounding. Option A is incorrect as it states an equality which does not hold in general. Option C is incorrect as it relates the real rate to the nominal rate, rather than the other way around. Option D is incorrect as it includes an addition instead of a subtraction in the equation.

We Can Write the True Relationship Between the Nominal Interest