You read in Business Week that a panel of economists has estimated that the long-run real growth rate of the U.S. economy over the next five-year period will average 3 percent. In addition, a bank newsletter estimates that the average annual rate of inflation during this five-year period will be about 4 percent. What nominal rate of return would you expect on U.S. government T-bills during this period?
To calculate the nominal rate of return on U.S. government T-bills during the given period, we need to consider both the real growth rate and the rate of inflation.
First, we'll calculate the real rate of return by subtracting the inflation rate from the real growth rate:
Real rate of return = Real growth rate - Inflation rate
Real rate of return = 3% - 4% = -1%
The real rate of return is negative, indicating that the purchasing power of the investment will decrease due to inflation.
To find the nominal rate of return, add the inflation rate to the real rate of return:
Nominal rate of return = Real rate of return + Inflation rate
Nominal rate of return = -1% + 4% = 3%
Therefore, we can expect a nominal rate of return of 3% on U.S. government T-bills during this five-year period.