8. The Fisher hypothesis and the cost of unexpected inflation Aa Aa Suppose the

Question

8. The Fisher hypothesis and the cost of unexpected inflation Aa Aa Suppose the nominal interest rate on car loans is 9% per year. If borrowers and lenders expect an inflation rate of 3% per year, the expected real interest rate is per year. Suppose that inflation rises unexpectedly from 3% to 6% per year. In the short run, the real interest rate on car loans will toper year. The unanticipated change in inflation arbitrarily harmsti Now consider the long-run impact of the change in money growth and inflation. According to the Fisher hypothesls, as expectations adjust to the new, higher inflation rate, the nominal interest rate will to per year. Grade It Now Save & Continue Continue without savin Copyright NoticesTerms of Use Privacy Notice Security Notice

Explanation / Answer

Answer

According to Fischer

Real interest rate = Nominal interest rate - Inflation

Hence Real Interest rate = 9 - 3 = 6%

Real Interest Rate decreases from 6% to 9 - 6 = 3%. Hence lender will recieve less real interest rate hence this harms LENDER

In the long run this unexpected change gets adjusted and Nominal Interest rate Increases from 9% to 9 + 3 =12 % ( According to Fischer there is a One for One Relation Between Nominal interest rate and Inflation and Real interest remains constant)

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