In year 1 the price level is constant and the nominal rate of interest is 6 percent. But in year 2 the inflation rate is 3 percent. If the real rate of interest is to remain at the same level in year 2 as it was in year 1, then in year 2 the nominal interest rate must
A) rise by 9 percentage points.
B) rise by 3 percentage points.
C) fall by 3 percentage points.
D) rise by 6 percentage points.

Question

Quizplus · Accepted Answer

The equation for the real interest rate is: 
Real interest rate = Nominal interest rate - Inflation rate

In year 1, the real interest rate was:
Real interest rate = 6% - 0% = 6%

To maintain the same real interest rate in year 2, we need to adjust the nominal interest rate to account for the 3% inflation rate: 
Real interest rate = Nominal interest rate - Inflation rate 
6% = Nominal interest rate - 3% 
Nominal interest rate = 9%

Therefore, the nominal interest rate must rise by 3 percentage points (from 6% to 9%) to maintain the same real interest rate in year 2 as it was in year 1.

In Year 1 the Price Level Is Constant and the Nominal