Which of the following best describes how banks determine what interest rate to charge?

Choose 1 answer:
(A) Expected real interest + expected inflation
(B) Real interest - real GDP growth rate
(C) Expected nominal interest + expected inflation
(D) Nominal interest - inflation
(E) Nominal interest + real GDP growth rate

Question

Which of the following best describes how banks determine what interest rate to charge?

Choose 1 answer:
(A) Expected real interest + expected inflation
(B) Real interest - real GDP growth rate
(C) Expected nominal interest + expected inflation
(D) Nominal interest - inflation
(E) Nominal interest + real GDP growth rate

Accepted Answer

∻Solution by Steps∻ ‖ step 1 ⋮ To understand how banks determine what interest rate to charge, we need to consider the components of the nominal interest rate. The Fisher Equation, which relates the nominal interest rate to the real interest rate and expected inflation, is given by: $ i = r + \pi $, where $ i $ is the nominal interest rate, $ r $ is the real interest rate, and $ \pi $ is the expected inflation rate. ‖ ‖ step 2 ⋮ The nominal interest rate is what banks charge borrowers, and it includes both the real rate of return that banks want to earn and the expected inflation, which compensates for the decrease in money's purchasing power over time. ‖ ‖ step 3 ⋮ By examining the options given, we can see that option (A) Expected real interest + expected inflation aligns with the Fisher Equation and the components of the nominal interest rate. ‖ ∻Answer∻ ***A*** ∻Key Concept∻ ⚹Fisher Equation⚹ ∻Explanation∻ ⚹The Fisher Equation explains that the nominal interest rate is determined by the sum of the expected real interest rate and the expected inflation rate.⚹◊What statistical methods can be used to analyze the relationships between different economic indicators like real interest rates and GDP growth⍭ Generate me a similar question◊

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