Assume That the Term Structure Effect and the Default-Risk Premium

question 74

Multiple Choice

Assume that the term structure effect and the default-risk premium remain unchanged and that households and firms have adaptive expectations.At the beginning of 2013,a bank is offering car loans at a nominal interest rate of 7% and the expected rate of inflation is 2 %,and at the beginning of 2014,the bank decreases the nominal interest rate to 5%.The real interest rate at the beginning of 2014 is

• A) 2%.
• B) 3%.
• C) 5%.
• D) This cannot be determined without being given the expected inflation rate for 2014.