How does a rise in the policy rate affect commercial bank lending?

Higher rates raise borrowing costs, so loan demand falls; banks may earn a wider spread, but total lending usually shrinks and money supply growth slows.

Which rate reflects purchasing power, nominal or real?

The real rate. The nominal rate is only the contractual figure; after deducting inflation it shows the actual change in purchasing power.

S5 Economics: Money and Banking Paper 2 (nominal and real interest rates, the central bank and the banking system)

2026-11-03

S · 5

This paper focuses on converting between nominal and real interest rates, the functions of a central bank, and the reserves and lending capacity of the banking system. Use the approximation of nominal minus inflation unless the item asks for the exact figure, in which case apply the Fisher equation; keep two decimal places, and every value here is checked by computer.

Quick answer　Real rate 5 percent; nominal 6 percent; the central bank lends when a bank is short of funds; real rate minus 2 percent; exact figure 3.81 percent; it rises; reserve 800 with 7,200 lendable; deposits of 6,000 billion; it stays at 3 percent; the error is that a negative real rate cuts purchasing power.

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: Money and Banking
Level	S5

02　Questions (10 items)

FoundationThe nominal interest rate is 8 percent and inflation is 3 percent. What is the real interest rate?
FoundationThe real interest rate is 2 percent and inflation is 4 percent. What is the nominal interest rate?
FoundationWhat does it mean that a central bank is the lender of last resort?
FoundationThe nominal rate is 4 percent and inflation is 6 percent. What happens to a depositor purchasing power?
IntermediateThe nominal rate is 9 percent and inflation is 5 percent. Use the Fisher equation to find the exact real rate to two decimal places.
IntermediateRising incomes raise money demand while money supply is unchanged. What happens to the short-term interest rate?
IntermediateA deposit of 8,000 dollars at a 10 percent reserve ratio: what are the required reserve and the lendable amount?
ChallengeThe banking system holds 450 billion in reserves at a 7.5 percent reserve ratio. What are total deposits?
ChallengeThe nominal rate rises from 5 to 7 percent and inflation from 2 to 4 percent. What happens to the real rate?
Error redoWith 7 percent inflation and a 3 percent nominal rate, someone claims that positive interest must raise purchasing power. What is wrong?

03　Answers and one-line notes

#	Answer	One-line note
1	5 percent.	The real rate is roughly nominal minus inflation: 8 minus 3 gives 5.
2	6 percent.	The nominal rate is roughly the real rate plus inflation: 2 plus 4 gives 6.
3	The central bank lends to commercial banks that are short of funds in the short run.	This function stops one bank a funding problem from spreading into a system-wide run.
4	The real rate is minus 2 percent, so purchasing power falls.	A negative real rate means interest income does not keep up with prices.
5	3.81 percent.	1.09 divided by 1.05 gives 1.0381; minus 1 and times 100 gives 3.81.
6	The interest rate rises.	With demand up and supply fixed, holders sell assets for money, asset prices fall and the rate rises.
7	The reserve is 800 dollars and 7,200 dollars may be lent.	8,000 times 0.10 gives 800, and 8,000 minus 800 gives 7,200.
8	6,000 billion.	450 divided by 0.075 gives 6,000, a multiplier of about 13.3.
9	It stays at 3 percent both before and after.	Both rose by 2 percentage points, so the difference is unchanged; this is the Fisher effect.
10	The claim looks only at the nominal rate; the real rate is minus 4 percent, so purchasing power falls.	Purchasing power must be judged by the nominal rate minus inflation.

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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