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Chapter 20: Problem 7

In April \(2016,\) the nominal interest rate on a one-year Treasury bill was 0.54 percent. From April 2016 to April \(2017,\) the consumer price index rose from 238.9 to \(244.2 .\) If you bought the one-year Treasury bill in April 2016, calculate the real interest rate you earned over the following 12 -month period. Given the results of your calculation, why were investors willing to buy Treasury bills in April \(2016 ?\)

Short Answer

Expert verified
First, the real interest rate is calculated by subtracting the inflation rate over the year (approximately \(2.22 \% \)) from the nominal interest rate, resulting in a negative real interest rate. Then, under the assumption of rational investors, despite the negative real rate, investors might have still been willing to buy these Treasury bills due to their relative safety and low risk, compared to other types of investments during this period.

Step by step solution

01

Define Given Information

The nominal interest rate is \(0.54\) percent. The Consumer Price Index (CPI) in April 2016 was \(238.9\) and in April 2017 it rose to \(244.2\). The task is to calculate the real interest rate.
02

Calculate Inflation Rate

The inflation rate is calculated by the formula: \( \frac{CPI_{new} - CPI_{old}}{CPI_{old}} \times 100\% \). In this case it would be: \( \frac{244.2 - 238.9}{238.9} \times 100\% \).
03

Convert Nominal Interest to Real Interest

The real interest rate is calculated by substracting the inflation rate from the nominal rate. Use the equation: Real Rate = Nominal Rate - Inflation, substituting the calculated values.
04

Explanation for Investment

Basing on the calculated real interest rate, deduce the reasons why investors were still willing to buy these Treasury bills.

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Most popular questions from this chapter

Briefly describe the three major measures of the price level.

In discussing the labor market during the recovery from the \(2007-\) 2009 recession, Federal Reserve Chair Janet Yellen noted that "the employment-to- population ratio has increased far less over the past several years than the unemployment rate alone would indicate, based on past experience." a. During an economic expansion, why would we normally expect the employment- population ratio to increase as the unemployment rate falls? b. Why didn't the employment-population ratio increase as much as might have been expected during the recovery from the \(2007-2009\) recession?

Discuss the likely effect of each of the following on the unemployment rate. a. The length of time workers are eligible to receive unemployment insurance payments doubles. b. The minimum wage is abolished. c. Most U.S. workers join labor unions. d. More companies make information about job openings easily available on Internet job sites.

During the last three months of \(2016,\) the employmentpopulation ratio was unchanged, and the labor force participation rate was decreasing. Shouldn't both of these data series move in the same direction? Briefly explain how it is possible that they didn't.

What are the problems in measuring the unemployment rate? In what ways does the official BLS measure of the unemployment rate understate the true degree of unemployment? In what ways does the official BLS measure overstate the true degree of unemployment?
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