Suppose the public expects a 7 percent inflation rate, and both the money supply and money demand grow at 7 percent a year. The Federal Reserve decides to keep the money growth rate at 7 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

In the short run, the nominal interest rate will adjust to match the expected inflation rate, which is 7 percent. Therefore, the real interest rate (nominal interest rate minus inflation rate) will remain constant.

Suppose the Public Expects a 7 Percent Inflation Rate, and Both