In 1999, the Canadian economy was at full employment. Real GDP was $886 billion,

Question

In 1999, the Canadian economy was at full employment. Real GDP was $886 billion, the nominal interest rate was around 6 percent per year, the inflation rate was 2 percent a year, the price level was 110, and the velocity of circulation was constant at 10.

(a)What is the real interest rate?

(b)If the real interest rate remains unchanged when the inflation rate increases to 4 percent a year, explain how the nominal interest rate changes.

(c)What was the quantity theory of money in Canada?

(d)If the quantity of money grows at a rate of 10 percent a year and potential GDP grows at 3 percent a year, what is the inflation rate in the long run?

Explanation / Answer

a.

Real interest rate = Nominal rate – Inflation rate

                            = 6% - 2%

                            = 4%

b.

Real interest rate is affected by the adjustment of inflation rate. If the real is fixed but inflation increases, it causes an increase in nominal rate too.

Real interest rate = Nominal rate – Inflation rate

                  4%    = Nominal rate - 4%

Nominal rate      = 4% + 4%

                           = 8%

Therefore, the nominal rate would be 8%.

Related Questions

Navigate

• Browse (All)
• Browse I
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.