Costs of Inflation: Financial Intermediation Failure Practice Questions | Marginal Revolution University

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Practice Questions

Costs of Inflation: Financial Intermediation Failure Practice Questions

Review how to solve questions 6 through 9 with this Office Hours: Costs of Inflation video.

1. The real interest rate is equal to: *

a. The inflation rate minus the nominal interest rate.

b. The nominal interest rate plus the inflation rate.

c. The nominal interest rate minus the inflation rate.

d. The nominal interest rate times the inflation rate.

2. How does inflation redistribute wealth when the rate is higher than expected? *

a. Unexpected inflation reduces the real return on a loan, so wealth moves from the lender to the borrower.

b. Unexpected inflation increases the real return on a loan, so wealth moves from the lender to the borrower.

c. Unexpected inflation raises prices, so wealth moves from buyers to sellers.

d. Unexpected inflation lowers prices so wealth moves from sellers to buyers.

3. The Fisher effect states that: *

a. Nominal interest rates will fall with expected inflation rates.

b. Nominal interest rates will fall with unexpected inflation rates.

c. Nominal interest rates will rise with unexpected inflation rates.

d. Nominal interest rates will rise with expected inflation rates.

4. If the inflation rate is expected to be 7% over the next year, and Bank of Bigbucks aims to secure a real return on loans of 6%, what will the bank set interest rates at for borrowers? *

a. 6%

b. 7%

c. 13%

d. 16%

5. Uncertainty about future inflation rates and the real rate of return on loans is problematic for the economy overall because: *

a. As prices increase borrowers have less disposable income to repay mortgages.

b. As interest rates rise, banks make exorbitant amounts of money and hoard it for the 1%.

c. As interest rates rise, government taxes must increase, leaving consumers with less disposable income.

d. As long-term lending become more costly and less common, the economy invests less.

Refer to the above table when solving the next four questions. Let’s see how taxes can affect your incentive to save when there is expected inflation. We know the government taxes any nominal interest you earn on a savings account, so for the following scenarios, assume a realistic 33% tax rate.

6. Calculate the nominal rate of return after taxes if the nominal interest rate is 6%. *

a. 6%

b. 4%

c. 2%

d. 1%

7. Now calculate the real rate of return after taxes, which takes inflation into account. In this scenario, inflation is 3%. *

a. 3%

b. 2%

c. 1%

d. -1%

8. Calculate the nominal rate of return after taxes if the nominal interest rate is 12%. *

a. 12%

b. 9%

c. 8%

d. 6%

e. 3%

9. Now calculate the real rate of return after taxes, which takes inflation into account. In this scenario, inflation is 9%. *

a. 9%

b. 6%

c. 3%

d. 1%

e. -1%

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Principles of Economics Macroeconomics

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Principles of Economics: Macroeconomics

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