Question

 6. The Fisher effect and the cost of unexpected inflation

 Suppose the nominal interest rate on savings accounts is 11% per year, and both actual and expected inflation are equal to 5%.

 Complete the first row of the table by filling in the expected real interest rate and the actual real interest rate before any change in the money supply.

 Now suppose the Fed unexpectedly increases the growth rate of the money supply, causing the inflation rate to rise unexpectedly from 5% to 6% per year.

 Complete the second row of the table by filling in the expected and actual real interest rates on savings accounts immediately after the increase in the money supply (MS).

 The unanticipated change in inflation arbitrarily benefits _______ 

 Now consider the long-run impact of the change in money growth and inflation. According to the Fisher effect, as expectations adjust to the new, higher inflation rate, the nominal interest rate will _______ to _______  % per year.

Answer 1

Ans.

Expected Real Interest rate = Nom. int.rate - Expected Inflation

Actual Real Interest rate = Nom. int. rate - Actual Inflation

Time Period	Nom. int. rate	Expected Infaltion	Actual Inflation	Exp. Real Int. Rate	Act. Real Int. rate
B. increase in MS	11	5	5	6	6
Imd. A. increase in MS	11	5	6	6	5

Blank 1 - it will benefit borrowers or the banks.

Blank 2 - rise to

Blank 3 - 12% ( 11% nominal int. rate + 1% rise occured due to money supply from 5% to 6% )

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