Multiple Choice
Which of the following is an inflation-adjusted return on a loan or bond (i.e., the real interest rate) according to the Fisher relationship?
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11. Unemployment and Inflation
Nominal Interest, Real Interest, and the Fisher Equation
Multiple Choice
Which of the following is an inflation-adjusted return (i.e., a measure of return that accounts for changes in the price level)?
A
The real interest rate
B
The inflation rate
C
The coupon payment on a bond
D
The nominal interest rate
Verified step by step guidance1
Step 1: Understand the difference between nominal and real values. The nominal interest rate is the stated rate without adjustment for inflation, while the real interest rate adjusts for changes in the price level.
Step 2: Recall the formula that relates nominal interest rate, real interest rate, and inflation rate: \(1 + r_{nominal} = (1 + r_{real})(1 + \pi)\), where \(r_{nominal}\) is the nominal interest rate, \(r_{real}\) is the real interest rate, and \(\pi\) is the inflation rate.
Step 3: Recognize that the real interest rate represents the inflation-adjusted return, meaning it shows the true increase in purchasing power after accounting for inflation.
Step 4: Understand that the inflation rate itself is not a return but a measure of how prices change over time, and coupon payments are fixed cash flows that do not adjust for inflation.
Step 5: Conclude that among the options, the real interest rate is the correct measure of inflation-adjusted return because it accounts for changes in the price level.
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