If expected inflation equals 3 percent and monetary policymakers push the nominal interest rate to 1 percent, the real interest rate equals ______ percent.
A) 4
B) 1
C) 0
D) -2

Question

Quizplus · Accepted Answer

The real interest rate is calculated by subtracting the expected inflation rate from the nominal interest rate. Therefore, the real interest rate would be -2 percent [(1 percent) - (3 percent) = -2 percent]. This means that the borrower would effectively be paying back less in real terms than they borrowed, while the lender would earn less in real terms than they loaned.

If Expected Inflation Equals 3 Percent and Monetary Policymakers Push