a)
How will the rate of interest will be affected if the inflation rises
a)
Explanation of Solution
A doubling of expected inflation from 3% to 6% leaves the real interest rate unchanged. This is because Fisher's law states that the expected future rate of inflation does not affect the real interest rate.
b)
Effect on the nominal interest rate
b)
Explanation of Solution
Nominal interest rates are affected. This is tripled because the nominal interest rate is related to the expected inflation rate. For example, if the starting nominal interest rate is 2% and the expected future inflation rate is 6%, the newly raised nominal interest rate is 8%.
c)
c)
Explanation of Solution
As inflation expectations rise, so does the demand and supply of borrowable funds. Rising inflation expectations will force borrowers and lenders to borrow and lend at higher nominal rates.
Chapter 29 Solutions
Krugman's Economics For The Ap® Course
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