Suppose Expected Inflation in the Economy Is 5

Essay

Suppose expected inflation in the economy is 5%.Banks set nominal interest rates so they'll earn a 2% expected real return.Employers set nominal wages based on a 2% expected real wage increase.Suppose the nominal interest rate and nominal wages are determined this way,but actual inflation turns out to differ from the expected inflation rate.Calculate the actual real interest rate and the percent increase in the real wage for each of the following actual inflation rates: a)2%; b)5%; c)10%.