If the expected inflation rate rises from 3% to 5% when the nominal interest rate is 4%,the Fisher effect asserts that the nominal interest rate would

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Quizplus · Accepted Answer

The Fisher effect states that the nominal interest rate will adjust to changes in the expected inflation rate, so when the expected inflation rate increases from 3% to 5%, the nominal interest rate will also increase to offset the increase in inflation. The formula for the Fisher effect is Nominal Interest Rate = Real Interest Rate + Expected Inflation Rate, so with a real interest rate of 1% (nominal interest rate of 4% - expected inflation rate of 3%), the nominal interest rate would need to increase to 6% to maintain the same real interest rate with an expected inflation rate of 5%.

If the Expected Inflation Rate Rises from 3% to 5