nominal interest rate

Examples of nominal interest rate in the following topics:

• The Demand for Money

  • Generally, the nominal demand for money increases with the level of nominal output and decreases with the nominal interest rate.
  • Specific to the liquidity function, L(R,Y), R is the nominal interest rate and Y is the real output.
  • However, when the demand for money is not stable, real and nominal interest rates will change and there will be economic fluctuations.
  • The interest rate is the rate at which interest is paid by a borrower (debtor) for the use of money that they borrow from a lender (creditor).
  • Interest-rate targets are a tool of monetary policy.

• Distribution Effects of Inflation

  • Assuming that loans must be paid back according to a nominal amount (i.e. the borrower must pay back $100 in one year), inflation is good for borrowers and bad for lenders.
  • This is because the inflation rate is built in to the nominal interest rate, which is the sum of the real interest rate and expected inflation.
  • For example, if the real cost of borrowing money is 3% and inflation is expected to be 4%, the nominal interest rate on a loan would be 7%.
  • The lower purchasing power of money erodes the value of currency, and inflation reduces the real interest rate earned on bonds.
  • Debtors find themselves paying a lower real interest rate than expected, and stocks tend to rise in value to reflect the inflation level.

• The Taylor Rule

  • Taylor's rule was designed to provide monetary policy guidance for how a central bank should set short-term interest rates.
  • The rule stipulates how much a central bank should change the nominal interest rate (real rate plus inflation) in response to changes in inflation, output, or other economic conditions.
  • In particular, the rule stipulates that for each one-percent increase in inflation, the central bank should raise the nominal interest rate by more than one percentage point.
  • what the level of the short-term interest rate is that would be consistent with full employment.
  • The Taylor rule advocates setting interest rates relatively high (contractionary policy) when inflation is high or when the employment rate exceeds the economy's full employment level.

• Shifts in the Money Demand Curve

  • The interest rate is the price of money.
  • The quantity of money demanded increases and decreases with the fluctuation of the interest rate.
  • It shifts in with the nominal interest rate.
  • The nominal interest rate declines and there is a greater interest advantage in holding other assets instead of money.
  • The graph shows both the supply and demand curve, with quantity of money on the x-axis (Q) and the price of money as interest rates on the y-axis (P).

• The Federal Reserve and the Financial Crisis of 2008

  • Lower interest rates stimulate loans, spending, and investment and help an economy escape from recession.
  • The zero lower bound refers to the fact that the central bank cannot push nominal interest rates below 0%.
  • When inflation is high, however, central banks may be able to push the real interest rate below 0%.
  • Recall that the nominal interest rate is the sum of the real interest rate and the expected inflation rate.
  • If the nominal interest rate is 1% and inflation is 3%, the real interest rate is -2%.

• Interest Rates and Economic Rationale

  • The interest rate is one of the primary influences on economic rationale.
  • The interest rate is the rate at which interest is paid by a borrower (debtor) for the use of money borrowed from a lender (creditor).
  • Interest rates also influence inflationary expectations.
  • Investments are made based on the nominal interest rate and the degree of risk involved.
  • The interest rates reached 14% in 1969 and lowered to 2% by 2003.

• Relationship Between Expectations and Inflation

  • Anything that is nominal is a stated aspect.
  • Suppose you are opening a savings account at a bank that promises a 5% interest rate.
  • This is the nominal, or stated, interest rate.
  • The real interest rate would only be 2% (the nominal 5% minus 3% to adjust for inflation).
  • The difference between real and nominal extends beyond interest rates.

• Using Monetary Policy to Target Inflation

  • Because interest rates and the inflation rate tend to be inversely related, the likely moves of the central bank to raise or lower interest rates become more transparent under the policy of inflation targeting.
  • if inflation appears to be above the target, the bank is likely to raise interest rates.
  • if inflation appears to be below the target, the bank is likely to lower interest rates.
  • Under the policy, investors know what the central bank considers the target inflation rate to be and therefore may more easily factor in likely interest rate changes in their investment choices.
  • They argue that a nominal income target is a better goal.

• Classical Theory

  • Classical theory, the first modern school of economic thought, reoriented economics from individual interests to national interests.
  • Classical theory reoriented economics away from individual interests to national interests.
  • Equality of savings and investment: classical theory assumes that flexible interest rates will always maintain equilibrium.
  • Calculating real GDP: classical theorists determined that the real GDP can be calculated without knowing the money supply or inflation rate.
  • Real and Nominal Variables: classical economists stated that real and nominal variables can be analyzed separately.

• Real Versus Nominal Rates

  • Real exchange rates are nominal rates adjusted for differences in price levels.
  • The real exchange rate is the nominal rate adjusted for differences in price levels.
  • The nominal exchange rate would be A/B 2, which means that 2 As would buy a B.
  • The real exchange rate is the nominal exchange rate times the relative prices of a market basket of goods in the two countries.
  • Calculate the nominal and real exchange rates for a set of currencies