People know that the inflation rate will increase from 3 percent to 5 percent. As a result
A) the nominal interest rate is constant.
B) the nominal interest rate falls by 2 percentage points.
C) the real interest rate rises by 2 percentage points.
D) the nominal interest rate rises by 2 percentage points.

Question

Quizplus · Accepted Answer

According to the Fisher equation, nominal interest rate = real interest rate + expected inflation rate. If the inflation rate is expected to increase from 3% to 5%, then the expected inflation rate increases by 2 percentage points. To keep the real interest rate constant, the nominal interest rate must rise by the same amount (2 percentage points). Therefore, the correct answer is D.

People Know That the Inflation Rate Will Increase from 3