If the nominal interest rate is 1 percent and the inflation rate is 5 percent, the real interest rate is:

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Prepare for the UCF ECO3203 Intermediate Macroeconomics Exam. Study with interactive flashcards and multiple choice questions, each providing insightful hints and explanations. Get ready to excel in your exam!

To determine the real interest rate, you can use the Fisher equation, which states that the real interest rate is approximately equal to the nominal interest rate minus the inflation rate. In this scenario, the nominal interest rate is 1 percent, and the inflation rate is 5 percent.

Using the formula:

Real Interest Rate = Nominal Interest Rate - Inflation Rate

Substituting the given values:

Real Interest Rate = 1 percent - 5 percent = -4 percent.

This result indicates that when the nominal interest rate is lower than the inflation rate, the purchasing power of money is actually declining, which is reflected in a negative real interest rate. Therefore, the correct answer is that the real interest rate is -4 percent, indicating that the cost of borrowing money is effectively greater when inflation is taken into account than the return on investments at the nominal rate.