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    Real vs nominal interest rates

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    You observe that the current interest rate on short-term U. S. Treasury bills is 4.76 percent. You also read in the newspaper that the Gross Domestic Product (GDP) deflator, which is a common macroeconomic indicator used by market analysts to gauge the inflation rate, currently implies that inflation is 3.3 percent. Given this information, what is the approximate real rate of interest on short- term Treasury bills? Is it likely that your answer would change if you used some alternative measure for the inflation rate, such as the Consumer Price Index (CPI)? What does this tell you about the observability and accuracy of real interest rates compared to nominal interest rates?

    © BrainMass Inc. brainmass.com December 24, 2021, 10:24 pm ad1c9bdddf
    https://brainmass.com/economics/inflation/real-nominal-interest-rates-472792

    SOLUTION This solution is FREE courtesy of BrainMass!

    Real interest rate is the nominal rate minus the inflation rate which gives us:
    4.76% - 3.3% =1.46%

    The GDP deflator includes goods and services produced, while CPI is based on a basket of goods and services consumed. For this reason, CPI is generallly greater than the GDP deflator. Changes in spending because of improvements in technology, for example, are automatically included in the GDP deflator. Therefore, CPI overstates inflation by about 1% point per year, and using it instead of the GDP deflator would result in a lower real interest rate.

    From this, we can see that real interest rates can only be inferred from our best guesses at inflation. They are not directly observable in the way that nominal rates are.

    This content was COPIED from BrainMass.com - View the original, and get the already-completed solution here!

    © BrainMass Inc. brainmass.com December 24, 2021, 10:24 pm ad1c9bdddf>
    https://brainmass.com/economics/inflation/real-nominal-interest-rates-472792

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