For this question, assume that the nominal interest rate does not change. In this situation, a decrease in expected inflation will cause:
A) an increase in investment.
B) an increase in the real interest rate.
C) a decrease in the real interest rate.
D) an increase in consumption.
E) an increase in money demand.

Question

Quizplus · Accepted Answer

A decrease in expected inflation will decrease the inflation premium, which is the additional nominal interest rate demanded by lenders to compensate for expected inflation. As the nominal interest rate remains the same, the real interest rate (nominal interest rate minus inflation) will increase, which reduces consumption and investment but increases savings.

For This Question, Assume That the Nominal Interest Rate Does