CAS EC 102 Lecture Notes - Lecture 4: Nominal Interest Rate, Real Interest Rate

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Inflation rate = rate i = r + r = i - . People make their decisions based on the real rate - it"s more relevant than the nominal. Expected inflation ^e i = r + ^e. They are paying their loans back in dollars that aren"t worth as much when they borrowed it. The real return to the lenders are higher and the real cost to the borrower is higher. Changes in the price level and internets rates. As price level goes up, inflation ( ) goes up. As inflation goes up, expected inflation ( ^e) goes up. As expected inflation ( ^e) goes up the nominal interest rate (i) goes up. Calculating what a past amount would be worth in a later year. Value in later years dollars = (value in earlier year dollars) (cpi later / cpi earlier) The inflation fallacy: most people think inflation erodes real incomes.

Related Questions

Suppose expected inflation was 2% and actual inflation was 4%. Then the ex post real interest rate was ---- than the ex ante real interest rate and there was a redistribution of wealth from ----.

a higher; borrowers to lenders

b higher; lenders to borrowers

c lower; borrowers to lenders

d lower; lenders to borrowers

Suppose that, in the short run, the price level is sticky (fixed) but nominal interest rates adjust to achieve equilibrium in the money market. According to the liquidity preference theory, if the central bank increases the money supply, then short-term nominal interest rates

a rise.

b fall.

c remain unchanged.

All else equal, if the ratio of reserves to deposits increases, the money supply

a increases

b decreases

c remains the same

Depreciation is tax-deductible but based on the historical cost of capital. If inflation is positive, then the corporate income tax ---- investment.

a encourages

b discourages

c has no effect on

If the price index for capital goods is the same as the price index for other goods, an index of the real cost of capital, in the absence of taxes, is the

a nominal interest rate plus the depreciation rate.

b real interest rate plus the depreciation rate.

c purchase price of a capital good multiplied by the sum of the nominal interest rate plus the depreciation rate.

d purchase price of a capital good multiplied by the sum of the real interest rate plus the depreciation rate.

Question 1

The higher the capital utilization rate, the greater the depreciation rate.

True

False

Question 2

Higher capital utilization rates may raise the user costs of capital because higher utilization rates imply

operating at inconvenient times.

paying overtime to employees operating the machines.

operating when complementary services like transporters are unavailable or more expensive.

All of the above.

Question 3

If the rental price of capital increase, the capital utilization rate

increases.

decreases.

remains the same.

depends on whether the substitution rate is greater than the income effect

Question 4

The vacancy rate in the labor market is

the number of job openings divided by the number of unemployed people in the labor force.

the number of job openings divided by the number of workers in the labor force.

the ratio of open jobs to filled jobs.

the ratio of open jobs to the total number of jobs that employers want occupied.

Question 5

Unemployment can exist in a market clearing model if it takes some search time for workers to find jobs.

True

False

Question 6

A decrease in workersâ effective real incomes while they are unemployed will

lower the job finding rate and raise the expected duration of unemployment.

lower the job finding rate and the expected duration of unemployment.

raise the job finding rate and lower the expected duration of unemployment.

raise the job finding rate and the expected duration of unemployment.

Question 7

In the Barro model, the natural rate of unemployment is

zero.

fixed.

Question 8

If the interest rate increases, the real demand for money also increases

True

False

Question 9

Commodity money is money that has value because

of the intrinsic value of the commodity.

it is legal tender.

the government says so.

All of the above.

Question 10

High-powered money is

money held by business for investment.

total currency in circulation plus depository institution deposits at the Fed.

total currency in circulation.

government bonds held by the public and depository institutions.

Question 11

U.S. M1 money includes

currency held by the public.

checkable deposits.

travelerâs checks.

All of the above.

Question 12

U.S. M2 money includes

currency, time deposits, and government bonds.

savings deposits, small time deposits, and private bonds.

checkable deposits, savings deposits, and small time deposits.

retail money market mutual funds, small time deposits, and government bonds.

Question

Money is different from other assets like capital and bonds in that

money does not pay interest.

money has intrinsic value.

money is a better long term store of value.

All of the above.

Question

If a personâs income doubles, we expect their cash holdings to

Question 15

Real money demand does not change when

nominal GDP changes.

the interest rate changes.

the price level changes.

All of the above.

Question 16

All else constant, the price level rises when the supply of money increases.

True

False

Question 17

If the nominal interest rate were to increase, then

money demand decreases and the price level increases.

money demand increases and the price level decreases.

the money supply and the price level would increase.

the money supply and the price level would decrease.

Question 18

Real money demand is a function of real GDP and the nominal interest rate.

True

False

Question 19

The real return on money is zero.

True

False

Question 20

If the expected inflation rate is 5% and the unexpected inflation rate is 4%, the actual inflation is

-1%

1.25%

Question 21

When the rate of growth of money is constant

the inflation rate equals the growth rate of money.

the nominal interest rate rises.

real money balances are declining.

All of the above.

Question 22

A decrease in the money growth rate in the market clearing model causes

a decrease in the nominal interest rate.

an increase in money demand.

a decrease in the price level.

All of the above.

Question 23

A decrease in the money growth rate in the market clearing model causes

an increase in the nominal interest rate.

an increase in money demand.

an increase in the price level.

All of the above.

Question 24

Under price level targeting the money supply becomes

Q 25 During a recession, the interest rate falls tending to cause money demand to rise, but is at least partly offset by real GDP falling tending to cause money demand to fall.

True

False

Short Answer/ProblemsâAnswer all numbered questions @ 10 points each. Provide your answers in the space provided or the back of the page. Make sure to scan all work pages. Any quantitative questions require showing your work for full credit. Round all $ problems to the nearest cent. All other calculations must be to at least the fifth decimal place. 1. Answer BOTH parts a & b below. a) Explain the impacts of low level unanticipated inflation for a country like the United States. b) In the United States, our confidence in our fiat money is derived from (3 things) 2. Given the following 4 scenarios: â¢ The contract interest rate was 6.5% and the expected inflation rate was 2.5%. â¢ The contract interest rate was 12% and the expected inflation rate was 10%. â¢ The contract interest rate was 7.5% and the expected inflation rate was 4%. â¢ The contract interest rate was 4% and the expected inflation rate was 1%. a) Indicate which scenario would have been best for the lender and explain why it is best for the lender. b) With an ex post actual inflation rate of 2.25%, indicate which scenario would have been best for society and explain why it is best for society of the four options. 3. Define, compare, and contrast two of the following sets of terms as they. a. organized exchange markets vs. OTC (over the counter) markets b. fiat money vs. representative full-bodied money c. adverse selection vs. moral hazard 4. Indicate what would happen to both M1 and M2 (increase, decrease, no change) due to each of the following events. Consider each lettered event to be independent of the others. a) you write a check for cash at the casino b) an individual redeems a personal CD and deposits the funds into a savings deposit account c) U.S. commercial banks use some of their excess reserves to purchase $250 billion worth of U.S. Treasury securities from the Federal Reserve. d) as the economy improves, banks ease their credit standards and approve a higher percentage of loan applications. e) you spend $4,000 in U.S. currency while on your spring break trip to Acapulco (if you spent less than that you could not have had much fun) Part III: Longer ProblemsâAnswer all numbered questions @ 15 points each. Provide your answers in the space provided or the back of the page. Make sure to scan all work pages. Any quantitative questions require showing your work for full credit. Round all $ problems to the nearest cent. All other calculations must be to at least the fifth decimal place. 5. The following is a historical list of median home prices in two states. Year State 1 ($) State 2 ($) GDP deflator (2009 base year) 1950 9,564 5,396 14.09 1960 15,100 9,800 17.56 1970 23,100 13,000 23.18 1980 84,500 43,900 46.05 1990 195,500 50,800 67.62 2000 211,500 74,400 82.59 2017 (estimate) 400,000 201,991 113.61 a. Convert each price into current year dollars. b. Determine how much a person would have had to pay in 1950 (for both states) to equal the 2017 real home value. c. For both states, determine the percentage increase in home values from 1950-2017 (one calculation for each). 6. Using the following information for a U.S. state: Nominal GDP Real GDP Population Year (millions) (millions 2009 $âs) 1,151,119 1,421,713 32,987,911 1998 1,879,520 1,975,457 36,020,878 2006 2,350,807 2,143,167 38,792,459 2014 a. What is the average annual growth rate for this state during the time periods listed? (Note: time periods of interest are 1998-2006 & 2006-2014) b. What is the average annual inflation rate for this state during the time periods listed? c. To what extent are living standards likely changing in this economy? Explain and support your claim using evidence from the above table. d. For 1 bonus point, indicate the U.S. state associated

CAS EC 102 Lecture Notes - Lecture 4: Nominal Interest Rate, Real Interest Rate

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