People know that the inflation rate will decrease from 7 percent to 3 percent. As a result
A) the nominal interest rate falls by 4 percentage points.
B) the nominal interest rate is constant.
C) the nominal interest rate rises by 4 percentage points.
D) the nominal interest rate equals 3 percent.

Question

Quizplus · Accepted Answer

The nominal interest rate typically reflects the real interest rate plus the expected inflation rate. If people expect inflation to decrease from 7 percent to 3 percent, the nominal interest rate would likely decrease by that difference (4 percentage points) to reflect the lower inflation expectations, assuming the real interest rate remains constant.

People Know That the Inflation Rate Will Decrease from 7