Question

If government bonds are currently paying 7% and the inflation rate is 2.1%, what is the approximate real rate? what is exact real rate?

Answer 1

Approximate real rate is calculated as follows,
As per Fisher equation formula,
i≈r+π
Where,
i means nominal interest rate
r means real interest rate
π means inflation rate
From the above equation we can find Approximate real interest rate as follows,
r≈i-π
r =i-π
r =0.07-0.021
r =0.049 i.e., 4.9%

Approximate real rate is 4.9%

Exact real rate is calculated as follows,
As per Fisher equation formula,
(1+i) =(1+r)(1+π)
Where,
i means nominal interest rate
r means real interest rate
π means inflation rate
From the above equation we can find exact real interest rate as follows,
r =((1+i) /(1+π))-1
r =((1+0.07) /(1+0.021))-1
r =0.04799 i.e., 4.799%
Exact real rate is 4.799%