Question
(e) Suppose not that the nominal interest rate is 5 percent (i = 0.05) and the ination rate is 2 percent ( = 0.02). Compute
(e) Suppose not that the nominal interest rate is 5 percent (i = 0.05) and the ination rate is 2 percent ( = 0.02). Compute the exact value and the approximate value for the real interest rate (r). Are they same now? How big is the mistake we would make if we use the approximate formula instead of the exact formula? (f) Some countries have large ination and interest rates. Consider now a country with an ination rate of 100 percent ( = 1) and a nominal interest rate of 110 percent (i = 1.1). What would be the exact value and the approximate value for the real interest rate (r)? How big is the mistake would make if we use the approximate formula instead of the exact formula? Do you think that the approximation can be used in high ination countries?
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