What is the formula for real interest rate?
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1. Nominal and real interest rates:
a. Explain the difference between real and nominal interest rates.
b. Which of these two interest rates is relevant for investment and consumption decisions and why?
c. How is the real interest rate calculated ex-post? How is the real interest rate calculated ex-ante?
2. Fisher parity
a. Write down the approximation formula of the Fisher parity.
b. What is the real interest rate if the nominal interest rate is 6% and the expected inflation rate is 1%?
c. How is the real interest rate affected if the expected inflation increases while the nominal interest rate remains constant?
d. Given that the nominal interest rate can’t be negative ("zero lower bound"), what is the lowest value the real interest rate can be?
What is the real GDP growth rate formula?
3. Suppose that a typical taxpayer has a marginal personal income tax rate of 20 percent. The nominal interest rate is 4 percent, and the expected inflation rate is 1 percent.
a. What is the real after-tax rate of interest?
b. Suppose that the expected inflation rate increases by 2 percentage points to 3 percent, and the nominal interest rate increases by the same amount. What happens to the real aftertax rate of return?
c. If the inflation rate increases as in part b, by how much would the nominal interest rate have to increase to keep the real after-tax interest rate at the same level as in part a? Can you generalize your answer using an algebraic formula?