In early 1996, the short-term interest rate in France was 3.7%, and forecast French inflation was 1.8%. At the same time, the short-term German interest rate was 2.6% and forecast German inflation was 1.6%.
- Based on these figures, what were the real interest rates in France and Germany?
- what would you attribute any discrepancy in real rates between France and Germany?
- Based on these figures, what were the real interest rates in France and Germany?
Answer. The French real interest rate was 1.037/1.018 – 1 = 1.87%. The corresponding real rate in Germany was 1.026/1.016 – 1 = 0.98%.
- To what would you attribute any discrepancy in real rates between France and Germany?
Answer. The most likely reason for the discrepancy is the inclusion of a higher inflation risk component in the French real interest rate than in the German real rate. Other possibilities are the effects of currency risk or transactions costs precluding this seeming arbitrage opportunity.
