Discuss how an autonomous increase in the expected rate of inflation will change

Question

Discuss how an autonomous increase in the expected rate of inflation will change the equilibrium nominal interest rate. Consider an initial real rate of interest of 2 percent and an expected inflation rate of 2 percent. If the expected rate of inflation falls to 0.0 percent with the real interest rate constant, what would the resulting nominal interest rate become, using the Fisher relationship? The reduction in the expected rate of inflation is considered to remain at the lower level indefinitely. Define your terms and discuss a recommended monetary policy to achieve economic stabilization with price stability and an improvement in the balance of payments.

Explanation / Answer

Fisher relationship (1+i) =(1+r) (1+pe)

(1+i) =(1+ 0.02)(1+0)

1+I = 1.02

I= .02

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