Calculate the inflation rate if the nominal interest rate is 5% and the real interest rate is 7%

The inflation rate can be calculated using the Fisher equation:

\[
(1 + \text{Nominal Interest Rate}) = (1 + \text{Real Interest Rate}) \times (1 + \text{Inflation Rate})
\]

Given:
- Nominal Interest Rate = 5% = 0.05
- Real Interest Rate = 7% = 0.07

Now, we solve for the inflation rate (\( \text{Inflation Rate} = i \)):

\[
(1 + 0.05) = (1 + 0.07)(1 + i)
\]

\[
1.05 = 1.07(1 + i)
\]

Divide both sides by 1.07:

\[
\frac{1.05}{1.07} = 1 + i
\]

\[
0.9813 = 1 + i
\]

Now, subtract 1 from both sides:

\[
i = 0.9813 - 1 = -0.0187
\]

So, the inflation rate is approximately **-1.87%**.

This negative inflation rate indicates deflation.

Would you like more details or have any questions? Here are some related questions:

1. What is the relationship between real and nominal interest rates?
2. How does deflation affect an economy?
3. What happens when the inflation rate is negative?
4. Can nominal interest rates be lower than real interest rates?
5. How do central banks adjust nominal interest rates in response to inflation?

**Tip:** Inflation can erode the purchasing power of money, so understanding the difference between nominal and real interest rates is essential for financial planning.

Learn how to calculate the inflation rate using the Fisher equation, given a nominal interest rate of 5% and a real interest rate of 7%. This solution includes a detailed step-by-step explanation, covering core concepts such as the Fisher Effect and interest rate relationships. Suitable for high school students in Grades 10-12.

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