In 1980, the real interest rate was -2.5%. Which of the following statements is correct?

Nominal Interest Rate is 11.0% and Inflation Rate is 13.5%.

a. The nominal interest rate is higher than the inflation rate in 1980.

b. All these statements are correct.

c. The real return is 2.5% less than the nominal rate.

d. The investment in Treasury bills lost purchasing power in 1980.

In 1980, the real interest rate was -2.5%. Which of the following statements is correct?

Well, you need some definitions here.

The nominal interest rate is the posted rate, and the number actually used when lending or borrowing money. All the rates you see in the newspaper are %26#039;nominal%26#039; rates.

The inflation rate rate is a general rise in prices, the higher the prices, the less stuff you get for a dollar.

This brings us to the real rate of return. That rate is how much real stuff you get back from lending your dollar. If you lend a dollar at no interest, and inflation is 3%, then you only get back 97%. So your real return is 0 - 3 or -3%. Now, if you charge a bit, say 5%, then even though inflation eats up 2%, you still get a real 3% return. This compensates you from parting with your money.

Now, in the above example, the inflation rate is a whopping 13.5%, but bankers only charge 11.0%. So the real rate was 11 - 13.5 or -2.5%. That is, they lost money on their investment due to inflation. Are they mad? Well, yes, but nonetheless it is likely they either had no other investments to make, or maybe they thought inflation wasn%26#039;t going to be that drastic when they made the loans.

I believe I have provided enough information to answer all the points except for the last one, which concerns something called Treasury bills and purchasing power. Let me take the easy one first: purchasing power is the name given by economists to represent the amount of real stuff money can buy. The second, Treasury Bills, are bills that people can purchase, and they will return an amount based on the nominal interest rate. So, the return on the Treasury Bill could have been 11.0%.

So, now you should be able to answer all the questions, and others like it.