Suppose the public expects a 4 percent inflation rate, while the Federal Reserve unexpectedly allows the money growth rate to be 5 percent. In the short run, we expect that
A) real interest rates will remain constant.
B) real interest rates may increase or decrease.
C) real interest rates will decrease.
D) real interest rates will increase.

Question

Quizplus · Accepted Answer

When the actual inflation rate exceeds the expected inflation rate, nominal interest rates may not adjust immediately, leading to a decrease in real interest rates in the short run. This is because real interest rate is approximately the nominal interest rate minus the inflation rate. If inflation is higher than expected, the real interest rate falls.

Suppose the Public Expects a 4 Percent Inflation Rate, While