Why does the long run call for the real interest rate rather than the nominal one?

Because purchasing power is set by the real rate. The nominal rate only restores the number of dollars, so if inflation exceeds it the real rate is negative and the deposit buys less.

Why does a higher cash leakage ratio lower the money multiplier?

After each loan only part of the money returns to the banks while the rest stays as cash in public hands, so fewer reserves are available to lend again and the same base money supports fewer deposits.

S5 Economics: Money and Banking Paper 1 (definition of money, deposit creation and real interest)

2026-11-03

S · 5

This paper links the definition of money, deposit creation and the Fisher equation: separate nominal from real interest, work out reserves and the multiplier, then use the exact Fisher relation to check purchasing power under inflation. Every value is checked by computer.

Quick answer　Real interest 4 percent; nominal 4 percent; medium of exchange, unit of account, store of value; multiplier 10 and deposits of 20,000; exact real rate 5.77 percent; real rate minus 3 percent; reserves of 400 and 4,600 lendable; 6,000 billion with less in practice; the real rate stays at 3 percent; the error is ignoring inflation, so the real rate is minus 1 percent.

01　Paper details (check answers afterwards)

Item	Detail
Questions	10 questions
Suggested time	25 minutes
Difficulty mix	Foundation 4 · Intermediate 3 · Challenge 2 · Error redo 1
Chapter	Chapter: S5 Economics: Money and Banking
Level	S5

02　Questions (10 items)

FoundationThe nominal interest rate is 6 percent and inflation is 2 percent. What is the real interest rate?
FoundationInflation is 3 percent and the real return on a deposit is 1 percent. What is the nominal interest rate, to a good approximation?
FoundationWhich function of money is used when paying for breakfast with a stored value card, comparing two goods by their price tags, and saving money for a trip next year?
FoundationThe required reserve ratio is 10 percent and the banks receive 2,000 dollars of new deposits with no cash leakage. What is the maximum total deposit?
IntermediateThe nominal rate is 10 percent and inflation is 4 percent. Use the exact Fisher relation, one plus i equals one plus r times one plus pi, to find the real rate to two decimal places.
IntermediateThe nominal rate falls to 2 percent while inflation rises to 5 percent. What is the real rate, and what does it mean for a saver?
IntermediateA customer deposits 5,000 dollars and the required reserve ratio is 8 percent. How much must be kept as reserves, and how much can be lent?
ChallengeTotal reserves are 300 billion dollars and the required reserve ratio is 5 percent. What is the theoretical maximum deposit, and if the public holds more cash, will the actual figure be above or below it?
ChallengeInflation rises from 2 to 6 percent while the nominal rate rises from 5 to 9 percent. How does the real rate change, and what is this called?
Error redoA student says that with 3 percent inflation and a 2 percent nominal rate the deposit still earns a gain. What is wrong, and what is the real rate?

03　Answers and one-line notes

#	Answer	One-line note
1	The real interest rate is 4 percent	Subtracting inflation from the nominal rate, 6 minus 2 gives 4, so the deposit gains 4 percent of purchasing power a year.
2	The nominal rate is about 4 percent	The nominal rate is roughly the real rate plus inflation, so 1 plus 3 gives 4.
3	Medium of exchange, unit of account and store of value, in that order	Paying is the medium of exchange, comparing price tags is the unit of account, and carrying purchasing power into the future is the store of value.
4	The multiplier is 10 and total deposits reach 20,000 dollars	One over 0.1 is 10, and 2,000 times 10 gives 20,000.
5	The real rate is 5.77 percent	One point one over one point zero four is 1.0577, so subtracting one gives 5.77 percent, slightly below the rough subtraction of 6 percent.
6	The real rate is minus 3 percent, so the deposit loses 3 percent of purchasing power a year	Two minus five is minus 3, so interest is paid in name only while the money buys less.
7	Reserves of 400 dollars and 4,600 dollars lendable	Five thousand times 0.08 gives 400 kept as reserves, leaving 4,600 to lend.
8	The maximum is 6,000 billion dollars, and the actual figure will be below it	Three hundred divided by 0.05 gives 6,000 billion at a multiplier of 20, and cash leakage keeps part of the base money outside the banks, so actual creation stays below the ceiling.
9	The real rate stays at 3 percent, which is the Fisher effect	Five minus two and nine minus six both give 3, since the nominal rate moves one for one with expected inflation and the real rate is unchanged.
10	The error is looking only at the nominal rate: the real rate is minus 1 percent, so purchasing power falls	Two minus three is minus 1, and a negative real rate means the same sum buys about 1 percent less after a year.

04　What to do after marking

After marking, redo only the wrong items and write down which step went wrong (formula, unit, or misread number).
Repeat the same item two days later; move to the next paper only when both attempts are correct.
Parents only need the answer and note columns; there is no need to explain every item.

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Questions and answers are written originally by the TutorZone team and are not taken from any school, publisher or examination authority paper. Every value is checked by computer.