Question

You lent $700 to a friend for one year at a nominal rate of interest of 4 percent. Inflation during that year was 3 percent. Did you experience an increase or decrease in the purchasing power of your money? How much did it increase or decrease?

Answer 1

Answer and Explanation:

Since the inflation is lesser than the nominal rate, the real rate has been positive.

Purchasing power increased by the real rate of interest

As per Fisher Equation

(1 + Real rate) =  (1 + Nominal rate)/(1 + Inflation)

= (1.04/1.03)

= 1.009701

Real rate = 0.009701    

               = 0.97%

Purchasing power increased by 0.97%