For a given nominal interest rate,an increase in expected inflation will cause
A)an increase in the real interest rate.
B)a reduction in the real interest rate.
C)a reduction in investment.
D)a reduction in money demand.

Question

Quizplus · Accepted Answer

An increase in expected inflation will reduce the purchasing power of the money that is received in the future, which means lenders will charge higher interest rates to compensate for the loss in value. However, borrowers will be willing to pay less interest as they are receiving less valuable money in the future. As a result, the real interest rate (nominal interest rate - expected inflation) will decrease. This will encourage borrowing and discourage saving, leading to a reduction in the real interest rate.

For a Given Nominal Interest Rate,an Increase in Expected Inflation