An investment offers a total return of 10 percent over the coming year. Janice Yellen thinks the total real return on this investment will be only 5 percent.

Problem 7-14 Nominal and Real Returns [LO4]
An investment offers a total return of 10 percent over the coming year. Janice Yellen thinks the total real return on this investment will be only 5 percent.



What does Janice believe the inflation rate will be over the next year? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer

The Fisher equation, which shows the exact relationship between nominal interest rates, real interest rates, and inflation is:



(1 + R) = (1 + r)(1 + h)



h = (1 + .10)/(1 + .05) – 1
h = .0476, or 4.76%