ECONOMICS
INFLATION
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Question
[CLICK ON ANY CHOICE TO KNOW THE RIGHT ANSWER]
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one-for-one relation between the inflation rate and the nominal interest rate
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one-for-one relation between the real and the nominal interest rate
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one-for-one relation between the inflation rate and the real interest rate
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none of the answers is correct
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Detailed explanation-1: -The Fisher Effect states that the real interest rate equals the nominal interest rate minus the expected inflation rate. Therefore, real interest rates fall as inflation increases, unless nominal rates increase at the same rate as inflation.
Detailed explanation-2: -When expected inflation changes, the nominal interest rate will increase. However, inflation will not affect the real interest rate.
Detailed explanation-3: -The Fisher effect is a theory first proposed by Irving Fisher. It states that real interest rates are independent of changes in the monetary base. Fisher basically argued that the nominal interest rate is equal to the sum of the real interest rate plus the inflation rate.
Detailed explanation-4: -The precise formula is (1 + nominal interest rate) = (1 + real interest rate) x (1 + inflation rate). Since this formula can be difficult to calculate, a more commonly used formula is i ≈ r + where i is the nominal interest rate, r is the real interest rate and is the inflation rate.
Detailed explanation-5: -Empirical evidence finds no support for a short-run Fisher effect in which a change in expected inflation is associated with a change in interest rates, but supports the existence of a long-run Fisher effect in which inflation and interest rates have a common stochastic trend when they exhibit trends.