When prices increase, the real interest rate
A) will increase and total planned spending on goods and services will increase.
B) will increase and total planned spending on goods and services will decrease.
C) will decrease and total planned spending on goods and services will decrease.
D) will not be affected.

Question

Quizplus · Accepted Answer

When prices increase, the nominal interest rate also increases to compensate for the decrease in the purchasing power of money. However, the real interest rate (nominal interest rate minus inflation rate) decreases. This decrease in real interest rate reduces the incentive for households and firms to save and invest, leading to a decrease in total planned spending on goods and services. Therefore, the correct answer is option B.

When Prices Increase, the Real Interest Rate