Question

Tom put his savings into a certificate of deposit that paid a nominal interest rate of 5 percent a year. During the year, the CPI increased from 240 to 250. What was the real interest rate that Tom earned? Round your answer up to the second decimal. Tom earned a real interest rate of _____ percent a year. Round your answer up to the second decimal.

Answer 1

Answer:

Explanation:

we will divide the consumer price index (CPI)  to get the inflation rate

250/240 -1 = 0.041666666666  =  1/24  = 4.17% inflation rate

Then we use the fisher equation to solve for the real rate.

Some economist and accountant calculate the real interest rate by subtracting inflation by nominal:

nominal - inflation

5% - 4.17% = 0.83% or

0.05 - 0.041666 =   0.008333 = 0.83%

However the correct way is using the fisher equation

$\frac{1+nominal}{1+inflation}  -1 = real rate[\tex]

solving using Fisher equation:

[tex]\frac{1+nominal}{1+inflation}  -1 = \\\\\frac{1+0.05}{1 + 1/24} -1  =  0.008 =  0.8%$