If prices are expected to decrease, and the nominal interest rate is close to zero,
A) the real interest rate will be less than zero, so investment spending will increase a lot.
B) the real interest rate could still be rather high, so investment spending will not be stimulated by an expansionary monetary policy
C) the real interest rate is unaffected, so investment spending continues as before.
D) the real interest rate is no longer important in investment spending decisions.

Question

Quizplus · Accepted Answer

When prices are expected to decrease (deflation), the real interest rate (nominal interest rate minus inflation rate) can actually increase if the nominal interest rate is close to zero and inflation is negative. This higher real interest rate makes borrowing more expensive, which can dampen investment spending, indicating that an expansionary monetary policy might not stimulate investment as intended.

If Prices Are Expected to Decrease, and the Nominal Interest