For central bankers to alter the real interest rate by changing the nominal interest rate, which of the following must be true?
A) The rate of inflation has to remain constant.
B) Inflation expectations are quite stable.
C) The expected rate of inflation has to change.
D) The change in the expected rate of inflation must equal the change in the nominal interest rate.

Question

Quizplus · Accepted Answer

Inflation expectations need to be quite stable for central bankers to alter the real interest rate by changing the nominal interest rate. If inflation expectations are volatile, then changes in the nominal interest rate may have unpredictable effects on the real interest rate, potentially causing economic instability. A stable inflation expectation allows for a clearer relationship between the nominal and real interest rates. A, C, and D are incorrect because the rate of inflation and the expected rate of inflation are not necessarily constant, nor do they have to change in tandem with changes in the nominal interest rate. Additionally, the change in the expected rate of inflation does not have to equal the change in the nominal interest rate for central bankers to alter the real interest rate.

For Central Bankers to Alter the Real Interest Rate by Changing