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In early 1996, the short-term interest rate in France was 5
In early 1996, the short-term interest rate in France was 5.7 percent, and forecast French inflation was 2.8 percent. At the same time, the short-term German interest rate was 2.6 percent and forecast German inflation was 1.6 percent.
What were the real interest rates in France and Germany? Why are they different?
Expert Solution
The real interest rate = ((1+n )/(1+i))-1
where n= nominal interest rate and i= inflation
Real interest rate for France= ((1+5.7%)/(1+2.8%))-1=1.028-1= .0282= 2.82%
Real interest rate for Germany= ((1+2.6%)/(1+1.6%))-1=1.0098-1= .0098= .98%
Thus the real interest rate for Germany is less than France
They are different because they have different short term interest rates (nominal rate) and inflation.
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