Question

Agree or disagree? 75 word reply

A nominal interest rate measures the change in dollar amounts. It is quoted on bonds and loans. Nominal interest rate is simple; for example, if you borrow $1000 at a 5% interest rate, you can expect to pay $50 in interest without taking inflation into account. The con of using the nominal interest rate is the fact that it does not adjust for the inflation rate. Whereas a real interest rate does take inflation into account. The real interest rate adjust for inflation and gives the real rate of a bond or loan. To find the real interest rate, you need the nominal interest rate first. Nominal rate - the expected or actual inflation rate = the real rate that lenders are receiving after inflation is factored in. For example, a bank loans a person $200,000 to purchase a house at a 3% rate. The 3% rate is the nominal interest rate, not factoring for inflation. Assume inflation rate is 2%. The real interest rate the bank is recieving is 1%. The purchase power of the bank only increases by 1%.

Answer 1

Purchasing power is the value of the currency by which goods and services can be bought with one unit it money. Real interest rate = Nominal Interest rate - Inflation. In this case, Real interest rate = 3% - 2%. Therefore, real interest rate = 1%. So the purchasing power of the bank will increase by 1% as the real interest rate is 1%.