Consider the following chart : Interest Rates (in percentage) The chart above shows the movement of nominal interest rates and real interest rates (defined as nominal interest rate minus inflation). Which one of the following is the correct interpretation ?

The identity Nominal interest = Inflation + Real interest implies that if nominal rates decline while real rates rise, inflation must be falling by a larger amount than the nominal decline [1]. This pattern is precisely what is described by disinflation — a steady decline in the inflation rate while it remains positive — which explains rising real rates despite lower nominal rates [2]. Option (3) therefore correctly interprets the chart: nominal rates can fall continuously while real rates increase steadily only if inflation is declining faster (disinflation). Options (1) and (2) assert ‘constant’ change which is stronger than required, and (4) would imply inflation reaching zero in 1994, a specific prediction not supported by the given identity and disinflation concept [2].

Sources

1. [1] Indian Economy, Vivek Singh (7th ed. 2023-24) > Chapter 2: Money and Banking- Part I > 2.28 Liquidity Trap > p. 111
2. [2] Indian Economy, Nitin Singhania .(ed 2nd 2021-22) > Chapter 4: Inflation > Disinflation > p. 74