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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?

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    Solution Preview

    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 ...

    Solution Summary

    The solution discusses how the measure of inflation affects the accuracy of real interest rates.