Answer:
The fisher's equation is -
(1 + Nominal interest rate i.e. i) = ( 1 + Real interest rate i.e. r ) ( 1 + Anticipated Inflation Premium i.e. π)
(1 + i) = (1 + π) + r (1 + π)
Hence, r = ( (1+i) - (1 + π) ) / (1 + π)
= (1 + i) / (1 + π) - 1
= ( 1 + 5.05 % ) / ( 1 + 1.25 % ) - 1
= (1.0505) / (1.0125) - 1
= 1.0375 - 1
= 0.0375 = 3.75 %
Hence , real interest rate is 1.6889 %.
One can also use the approximate version of Fisher's equation which is -
Nominal Interest rate = Real interest rate + Expected inflation premium
i = r + π
r = i - π
= 5.05 % - 1.25 %
= 3.8 %
Explanation:
Refer to the answer.
