What is the inflation rate? If GDP deflator rises from 100 in year 1 to 107
in year 2 and 115 in year 3, what will be the inflation rate between year 1
and year 2 and between year 2 and year 3? Also, if the nominal interest
rate is 9 % pa during all years, what are the corresponding real rates of
interest
The inflation rate is the rate at which the general level of prices for goods and services is rising, resulting in a decrease in the purchasing power of a currency. It is usually expressed as a percentage.
To calculate the inflation rate between two periods, you need to compare the changes in the GDP deflator. The GDP deflator is a measure of the level of prices of all new goods and services produced in an economy.
To calculate the inflation rate between year 1 and year 2, you can use the following formula:
Inflation rate = ((GDP deflator in year 2 - GDP deflator in year 1) / GDP deflator in year 1) * 100
Substituting the values given, we get:
Inflation rate between year 1 and year 2 = ((107 - 100) / 100) * 100 = 7%
To calculate the inflation rate between year 2 and year 3, you can use the same formula:
Inflation rate between year 2 and year 3 = ((GDP deflator in year 3 - GDP deflator in year 2) / GDP deflator in year 2) * 100
Substituting the values given, we get:
Inflation rate between year 2 and year 3 = ((115 - 107) / 107) * 100 = 7.48%
Now, let's calculate the corresponding real rates of interest. The real interest rate takes into account the effects of inflation on the nominal interest rate.
To calculate the real interest rate, you can use the following formula:
Real interest rate = Nominal interest rate - Inflation rate
Substituting the given nominal interest rate of 9% and the calculated inflation rates, we get:
Real interest rate between year 1 and year 2 = 9% - 7% = 2%
Real interest rate between year 2 and year 3 = 9% - 7.48% = 1.52%
Therefore, the corresponding real rates of interest between year 1 and year 2 and between year 2 and year 3 are 2% and 1.52%, respectively.