nominal vs real interest rates

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Last updated 2:26 PM on 9/20/26
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11 Terms

1
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nominal vs real value of money

nominal: the amount we have

real: its purchasing power (the amount it can buy)

2
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nominal vs real intersticio rates

nominal: compares amount of money we have

real: compares purchasing powers

3
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which is more commonly used for interest rates

nominal

4
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give an example using coke of how the growth of your money can be illustrated using nominal and real interest rates

one can costs £1 today
i have £2
so I can buy 2


one can costs £1.05 next year
i have £2.20 after growing my money at a 10% nominal interest rate
so I can buy 2.095 cans


so my 2 pounds has grown by 10% (nominal interest rate)
but my purchasing power has only grown by 4.76% (real interest rate)

5
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notation for purchasing power today and purchasing power after one period

PP0 for today

PP1 for after one period

6
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so then what is the formula for real interest rates, using purchasing powers

so this is like when I divided the 2.095 cans by 2 cans which gave me 1.0476 in the last question, meaning that real interest rate is 4.76%

<p>so this is like when I divided the 2.095 cans by 2 cans which gave me 1.0476 in the last question, meaning that real interest rate is 4.76%</p>
7
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what notation do we often use for inflation

pi, but it can be set to equal a different value (eg. pi = 5)

8
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give a different equation for 1 + real interest rates, that involves r and pi, using the Coca Cola example to derive it

might take u a minute but it does make sense eventually i promise

<p>might take u a minute but it does make sense eventually i promise</p>
9
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so therefore what is the fisher equation

as pictured


r = nominal interest rate

ireal = real interest rate

pi = expected inflation rate

<p>as pictured</p><p></p><p>r = nominal interest rate</p><p><em>i<sub>real</sub> = </em>real interest rate</p><p><span>pi = expected inflation rate</span></p>
10
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when you expand the fisher equation, what do you get

since both inflation and real interest rates will be low, them multiplied together can be approximated to zero

so by the time you’ve expanded brackets and simplified it will look as pictured


only an ESTIMATE

<p>since both inflation and real interest rates will be low, them multiplied together can be approximated to zero</p><p>so by the time you’ve expanded brackets and simplified it will look as pictured</p><p></p><p>only an ESTIMATE</p>
11
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if we use this estimation to work out ireal first, what do we apply that to in order to solve a question

multiply it by the NUMBER OF ITEMS so you can see the increase in PURCHASING POWER


so like in this question you would multiply it by the initial 20 cans you could buy, to get 21.6 cans (only an estimate tho - the method u would more naturally use will actually give u the accurate answer of 21.43 cans)

<p>multiply it by the NUMBER OF ITEMS so you can see the increase in PURCHASING POWER</p><p></p><p>so like in this question you would multiply it by the initial 20 cans you could buy, to get 21.6 cans (only an estimate tho - the method u would more naturally use will actually give u the accurate answer of 21.43 cans)</p>