In the IS- LM model, an increase in expected inflation will cause which of the following?
A) An increase in output.
B) A decrease in the real interest rate.
C) An increase in the nominal interest rate.
D) All of the above.
E) None of the above.

Question

Quizplus · Accepted Answer

An increase in expected inflation in the IS-LM model leads to an increase in output as firms and consumers are encouraged to spend and invest more before prices go up further. It also leads to a decrease in the real interest rate because the nominal interest rate may not immediately adjust to the higher inflation expectation, making borrowing cheaper in real terms. Additionally, over time, the nominal interest rate is likely to increase as lenders demand higher rates to compensate for the expected loss of purchasing power due to inflation. Therefore, all of the mentioned effects (A, B, C) are correct.

In the IS- LM Model, an Increase in Expected Inflation