. Suppose that the nominal rate of interest is 4 percent and the inflation premi

Question

. Suppose that the nominal rate of interest is 4 percent and the inflation premium is 2 percent. a. What is the real interest rate? b. Alternatively, assume that the real interest rate is 1 percent and the nominal interest rate is 6 percent. What is the inflation premium? Suppose that consumer spending initially rises by $5 billion for every 1 percent rise in household wealth and that investment spending initially rises by $20 billion for every 1 percentage point fall in the real interest rate. Also assume that the economy's multiplier is 4 4. a. If household wealth falls by 5 percent because of declining house valtues, and the real interest rate falls by 2 percentage points, in what direction and by how much will the aggregate demand curve initially shift at each price level? by billion The aggregate demand curve will shift b. Also assume that the economy's multiplier is 4. In what direction and by how much will it eventually shift? by billion The aggregate demand curve will shift

Explanation / Answer

Q3
Answer
a)
real interest rate=nominal interest rate-inflation
=4-2=2%

b)
inflation=nominal interest rate-real interest rate
=6-1=5%

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