Answer to Question #188797 in Macroeconomics for Talhabukhari

Question

According to a Fisher effect, how how does an increase in theinflation rate affect 

the real interest rate and nominal interest rate?

Answer 1

Solution:

The Fisher Effect is an economic theory that describes the relationship between inflation, and both real and nominal interest rates.

 

According to the Fisher Effect, the real interest rate equals the nominal interest rate minus the expected inflation rate. Therefore, an increase in the inflation rate will lead to a fall in real interest rates and vice versa. Nominal rates will also decrease when the inflation rate increase. Similarly, a decrease in the inflation rate will result in an increase in nominal rates.