Question

1. The nominal interest rate (the interest you pay for your financial borrowing) in Sri Lanka is about 13% while in Kuwait it is about 4%.  Discuss the possible reasons for the big difference in nominal interest rates in two countries.

2. In the CPI estimation, the basket of goods and services that are consumed by an average family is kept constant.  What are the implications of keeping the basket constant? Should we keep the basket constant all the time forever?

   

Answer 1

1) Nominal Interest rate = Real Interest + Inflation Rate

Nominal Interest rate in Sri Lanka = 13%

Nominal Interest rate in Kuwait = 4%

• There can be a case that there is high inflation rate is Sri Lanka than Kuwait.  
• Higher purchasing power of money or we can say higher real rate of Interest in Kuwait.

2) CPI captures the average price of basket of goods regularly consumed by consumers. If CPI is kept constant, we can say that there is no change in cost of basket in several years. We keep the cost of basket constant to raise the standard of living of poor section of society. We should not keep CPI constant because a healthy rate of growth of CPI (usually 3-4%) is always good because annual increase in nominal wage with increase in price of basket of goods keep real wage same.