What do you expect to happen to prices in Japan, given nominal interest rates of 10% in Canada and 6% in Japan, and expected Canadian inflation of 6%?
A)Expected Japanese inflation is 1.79%
B)Expected Japanese inflation is 2.11%
C)Expected Japanese inflation is 6.22%
D)Expected Japanese inflation is 10.00%

Question

Quizplus · Accepted Answer

According to the Fisher effect, the expected nominal interest rate in a country should equal its real interest rate plus expected inflation. Therefore, the expected real interest rate in Japan is 6% - expected inflation in Japan. If we assume that the real interest rate in Canada and Japan are the same, then 10% = 6% + expected Canadian inflation and expected Canadian inflation is 4%. Using the same equation for Japan, 6% = expected Japanese inflation + expected real interest rate in Japan, which we already solved for. Therefore, expected Japanese inflation is 2%.

What Do You Expect to Happen to Prices in Japan