Say that initially the nominal interest rate is 6% and prices are stable, but the inflation rate the following year rises to 3%. If the real rate of interest is to remain unchanged, the nominal interest rate in the second year must:
A)rise by 9 percentage points.
B)rise by 6 percentage points.
C)rise by 3 percentage points.
D)remain unchanged.

Question

Say that initially the nominal interest rate is 6% and prices are stable, but the inflation rate the following year rises to 3%. If the real rate of interest is to remain unchanged, the nominal interest rate in the second year must:
A)​rise by 9 percentage points.
B)​rise by 6 percentage points.
C)​rise by 3 percentage points.
D)remain unchanged.

Quizplus · Accepted Answer

The real interest rate is the nominal interest rate minus the inflation rate. In this scenario, the real interest rate is initially 6% - 0% = 6%. If the inflation rate the following year rises to 3%, the real interest rate must remain unchanged at 6%.

To keep the real interest rate at 6%, the nominal interest rate in the second year must be the sum of the real interest rate (6%) and the new inflation rate (3%). Therefore, the nominal interest rate in the second year should rise by 3 percentage points (from 6% to 9%).

Option C) is therefore the correct answer.

Say That Initially the Nominal Interest Rate Is 6% and Prices