Assume the long-term real interest rate is 4% and the expected inflation rate is 5%.If the Bank of Canada decreases the money supply and as a result,the expected inflation rate decreases to 2%,then based on the Fisher effect,the long-term real interest rate will ________ and the long-term nominal interest rate will ________.
A) remain at 4%; rise to 7%
B) remain at 4%; fall to 6%
C) fall to 1%; fall to 6%
D) fall to 6%; remain at -1%

Question

Quizplus · Accepted Answer

According to the Fisher effect, the long-term nominal interest rate equals the sum of the expected real interest rate and the expected inflation rate. Therefore, if the expected inflation rate decreases from 5% to 2%, the long-term nominal interest rate will decrease from 9% (4% real interest rate + 5% expected inflation rate) to 6% (4% real interest rate + 2% expected inflation rate). The long-term real interest rate will remain unchanged at 4%.

Assume the Long-Term Real Interest Rate Is 4% and the Expected