In December 2008, some economists forecast deflation for the coming year—a decrease in the price level, and therefore a negative inflation rate. Suppose a lender at that time expected deflation over the next twelve months of −1.0 percent, and loaned out funds for one year at a nominal annual interest rate of 0.5 percent.
a. What real interest rate was the lender expecting to get on the loan? [Use the approximation rule.]
b. The inflation rate from December 2008 to December 2009 was actually 1.5 percent. What real interest rate did the lender actually earn on the loan?