According to the Fisher hypothesis, if the real interest rate is 2 percent and the inflation rate falls from 3 percent to 1 percent, then the nominal interest rate will_____percentage points and the real interest rate will decline by______ percentage points.
A)decline by 0; 2
B)increase by 2; 2
C)increase by 0; 0
D)decline by 2; 0 percentage points and the real interest rate will decline by

Question

According to the Fisher hypothesis, if the real interest rate is 2 percent and the inflation rate falls from 3 percent to 1  percent, then the nominal interest rate will_____percentage points and the real interest rate will decline by______ percentage points. 
A)decline by 0; 2
B)increase by 2; 2
C)increase by 0; 0
D)decline by 2; 0 percentage points and the real interest rate will decline by

Quizplus · Accepted Answer

According to the Fisher hypothesis, the nominal interest rate is equal to the real interest rate plus the expected inflation rate.
Initially, the nominal interest rate would have been 5% (real interest rate of 2% + inflation rate of 3%). 
When the inflation rate falls to 1%, the nominal interest rate should fall by the same amount to 3% (real interest rate of 2% + inflation rate of 1%). So, the nominal interest rate will decline by 2 percentage points.
Since the real interest rate remains constant at 2%, the decline in the nominal interest rate means that the inflation rate has declined by 2 percentage points, from 3% to 1%.

According to the Fisher Hypothesis, If the Real Interest Rate