Question

Use the Fisher Effect to find the answer the following questions.

a. Nominal interest rate = 9%, real interest rate = 5%, what is inflation?

b. Nominal interest rate = 8%, inflation = 3%, what is the real interest rate?

c. Real interest rate = 6%, inflation = 2%, what is the nominal interest rate?

Answer 1

The "Exact Version" of Fisher Effect states:

(1 + N) = (1 + R) x (1 + F)

The approximate version of Fisher effect states:

N = R + F, where

N: nominal rate, R: Real rate and F: Inflation rate

(a)

(1) Exact version:

(1 + 0.09) = (1 + 0.05) x (1 + F)

1.09 = 1.05 x (1 + F)

1 + F = 1.05 / 1.09 = 1.0381

F = 0.0381 = 3.81%

(2) Approximate verison

9% = 5% + F

F = 4%

(b)

(1) Exact version

(1 + 0.08) = (1 + R) x (1 + 0.03)

1.08 = (1 + R) x 1.03

1 + R = 1.08 / 1.03 = 1.0485

R = 0.0485 = 4.85%

(2) Approximate version

8% = R + 3%

R = 5%

(c)

(1) Exact version

1 + N = (1 + 0.06) x (1 + 0.02)

1 + N = 1.06 x 1.02

1 + N = 1.0812

N = 0.0812 = 8.12%

(2) Approximate version

N = 6% + 2% = 8%