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Just suppose . . .

Suppose that the rate of interest is low, say, 1%. Suppose further that the rate of inflation is negative, say, -3%. A negative rate of inflation signifies a deflation, of course. Then what would be the real interest rate?

a) 4%

b) 2%

c) -2%

d) -4%

The answer is (a) or 4%. Use the Fisher effect to answer this question.