An increase in the interest rate by the Federal Reserve will affect only real interest rates because:
A) inflation is sticky in the short run.
B) of the quantity theory of money.
C) prices are flexible in the short and long runs.
D) contracts apply only in the very short run.
E) we are in the long run.

Question

Quizplus · Accepted Answer

An increase in the nominal interest rate by the Federal Reserve will lead to an increase in the real interest rate only if inflation is sticky in the short run. This is because in the short run, prices are not flexible enough to adjust to changes in nominal interest rates. As a result, an increase in the nominal interest rate will result in a decrease in inflation expectations, leading to an increase in the real interest rate. In the long run, however, prices become more flexible and inflation expectations adjust, leading to a smaller or no real effect on the interest rate.

An Increase in the Interest Rate by the Federal Reserve