Question

Consider the figure below

14 12 10 レ、 8 6 Q. 4 2 -2 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14

The figure depicts the trends in the nominal and real interest rates. You do not need to assume that there is a zero lower bound on nominal rates. Suppose you are told that the top (pink) trend line is the real interest rate. It would generally be true that this economy exhibits

deflation
inflation
constant price levels
0 0
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Answer #1

Option A. Deflation.

This is because Real interest rate = Nominal interest rate - Inflation rate. Since real interest rate is greater than nominal interest rate, inflation rate has to be negative which makes real interest rate greater than nominal interest rate and thus economy is experiencing deflation.

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