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Consider the following statements.
1. Real interest rate is always lower than the normal interest rate.
2. To neutralize the effects of inflation premium, the lender takes the recourse to decrease the nominal rate of interest.
Which of these statements is/are correct?
- a)None of them
- b)2 Only
- c)Both 1 and 2
- d)1 Only
Correct answer is option 'A'. Can you explain this answer?
Most Upvoted Answer
Consider the following statements.1. Real interest rate is always lowe...
Explanation:
Real interest rate and normal interest rate are two different concepts. Real interest rate is the nominal interest rate adjusted for inflation, while normal interest rate is the rate at which the demand for credit equals the supply of credit.
1. Real interest rate is always lower than the normal interest rate - False
Real interest rate can be higher or lower than the normal interest rate depending upon the inflation rate. If the inflation rate is high, the real interest rate will be lower than the normal interest rate, and vice versa.
For example, if the nominal interest rate is 10% and the inflation rate is 5%, the real interest rate will be 5%. However, if the inflation rate is 15%, the real interest rate will be -5%, which means the borrower is paying less in real terms than what he has borrowed.
2. To neutralize the effects of inflation premium, the lender takes the recourse to decrease the nominal rate of interest. - False
Inflation premium is the additional return that lenders demand to compensate for the loss in purchasing power due to inflation. To neutralize the effects of inflation premium, the lender can increase the nominal rate of interest, not decrease it.
For example, if the inflation rate is 5% and the lender wants to earn a real rate of return of 5%, he will charge a nominal rate of interest of 10%. This means that the borrower will pay an additional 5% as inflation premium.
Conclusion:
Both the statements given in the question are false. Real interest rate can be higher or lower than the normal interest rate depending upon the inflation rate. To neutralize the effects of inflation premium, the lender can increase the nominal rate of interest, not decrease it.
Real interest rate and normal interest rate are two different concepts. Real interest rate is the nominal interest rate adjusted for inflation, while normal interest rate is the rate at which the demand for credit equals the supply of credit.
1. Real interest rate is always lower than the normal interest rate - False
Real interest rate can be higher or lower than the normal interest rate depending upon the inflation rate. If the inflation rate is high, the real interest rate will be lower than the normal interest rate, and vice versa.
For example, if the nominal interest rate is 10% and the inflation rate is 5%, the real interest rate will be 5%. However, if the inflation rate is 15%, the real interest rate will be -5%, which means the borrower is paying less in real terms than what he has borrowed.
2. To neutralize the effects of inflation premium, the lender takes the recourse to decrease the nominal rate of interest. - False
Inflation premium is the additional return that lenders demand to compensate for the loss in purchasing power due to inflation. To neutralize the effects of inflation premium, the lender can increase the nominal rate of interest, not decrease it.
For example, if the inflation rate is 5% and the lender wants to earn a real rate of return of 5%, he will charge a nominal rate of interest of 10%. This means that the borrower will pay an additional 5% as inflation premium.
Conclusion:
Both the statements given in the question are false. Real interest rate can be higher or lower than the normal interest rate depending upon the inflation rate. To neutralize the effects of inflation premium, the lender can increase the nominal rate of interest, not decrease it.
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Consider the following statements.1. Real interest rate is always lowe...
- The bonus brought by inflation to the borrowers is known as the inflation premium. The interest banks charge on their lending is known as the nominal interest rate, which might not be the real cost of borrowing paid by the borrower to the banks.
- To calculate the real cost a borrower is paying on its loan, the nominal rate of interest is adjusted with the effect of inflation and thus the interest rate we get is known as the real interest rate.
- The real interest is always lower than the nominal interest rate if the inflation is taking place the difference is the inflation premium. Rising inflation premium shows depleting profits of the lending institutions. A
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Consider the following statements.1. Real interest rate is always lower than the normal interest rate.2. To neutralize the effects of inflation premium, the lender takes the recourse to decrease the nominal rate of interest.Which of these statements is/are correct?a)None of themb)2 Onlyc)Both 1 and 2d)1 OnlyCorrect answer is option 'A'. Can you explain this answer?
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Consider the following statements.1. Real interest rate is always lower than the normal interest rate.2. To neutralize the effects of inflation premium, the lender takes the recourse to decrease the nominal rate of interest.Which of these statements is/are correct?a)None of themb)2 Onlyc)Both 1 and 2d)1 OnlyCorrect answer is option 'A'. Can you explain this answer? for UPSC 2025 is part of UPSC preparation. The Question and answers have been prepared according to the UPSC exam syllabus. Information about Consider the following statements.1. Real interest rate is always lower than the normal interest rate.2. To neutralize the effects of inflation premium, the lender takes the recourse to decrease the nominal rate of interest.Which of these statements is/are correct?a)None of themb)2 Onlyc)Both 1 and 2d)1 OnlyCorrect answer is option 'A'. Can you explain this answer? covers all topics & solutions for UPSC 2025 Exam. Find important definitions, questions, meanings, examples, exercises and tests below for Consider the following statements.1. Real interest rate is always lower than the normal interest rate.2. To neutralize the effects of inflation premium, the lender takes the recourse to decrease the nominal rate of interest.Which of these statements is/are correct?a)None of themb)2 Onlyc)Both 1 and 2d)1 OnlyCorrect answer is option 'A'. Can you explain this answer?.
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