Question

Expected inflation theories: backward, etc. - please answer this question. I need the answer...now.

Answer 1

The fisher effect which says that real interest rate equals to nominal interest rate minus the expected inflation rate. This is called the expected inflation theory. Therefore, real interest rates fall as inflation increases, unless nominal rates increase at the same rate as inflation.

Every time we go the bank, we get the nominal interest rates there. If you are getting 10% interest rate from your bank on your deposit, do not be happy as this is the mixture of real interest rate and inflation level. Lets say there is 4% inflation in the economy, that means you are getting only 6% growth in your money. If there is high expected inflation in the future, that cause inflation to be rise now because if people assumes that inflation would be 7% in the future, they started consuming more as their purchasing power will decline in the future or they started storing products which can be long lasting. As demand for products increases, supplier raises the prices which cause inflation.