A country is experiencing an inflationary gap in the economy. The government decides to sell bonds on the open market. Interest rates will increase, but what is the new interest rate? Real or Nominal?

Expert Answers

An illustration of the letter 'A' in a speech bubbles

There is currently insufficient information to answer this question. We need to know the current rate of inflation, the current interest rate, and the quantity of bonds to be sold. It would also be helpful to have the IS and LM curves plotted or written as equations. That is, assuming...

Unlock
This Answer Now

Start your 48-hour free trial to unlock this answer and thousands more. Enjoy eNotes ad-free and cancel anytime.

Start your 48-Hour Free Trial

There is currently insufficient information to answer this question. We need to know the current rate of inflation, the current interest rate, and the quantity of bonds to be sold. It would also be helpful to have the IS and LM curves plotted or written as equations. That is, assuming we're using the IS-LM model, but that would be the usual method of solving a problem like this.

In general, what you would do is shift out the LM curve by the quantity of bonds sold, and then find its new intersection with the IS curve. This is the new equilibrium real interest rate. Add that to the rate of inflation and we have the new nominal interest rate. All of this is assuming that our bond sales haven't actually changed the inflation rate; if we have, we need to be using a model that takes that into account.

Approved by eNotes Editorial Team