Suppose that velocity and output are constant, the quantity theory and Fisher effect are correct, the nominal interest rate is 14 percent, and money growth is 6 percent. Which statement is consistent with these facts?
A) The real interest rate is 6 percent, and nominal wages are rising.
B) The real interest rate is 6 percent, and real wages are rising.
C) The real interest rate is 8 percent, and nominal wages are rising.
D) The real interest rate is 20 percent, and real wages are rising.

Question

Quizplus · Accepted Answer

Given the Fisher effect, the real interest rate can be calculated by subtracting the inflation rate from the nominal interest rate. If the quantity theory of money is correct and velocity is constant, then the inflation rate is equal to the money growth rate, which is 6 percent. Therefore, the real interest rate is 14 percent (nominal interest rate) minus 6 percent (inflation rate), which equals 8 percent. Since the question states that output is constant, it implies that if nominal wages are rising, it is likely due to inflation, making option C correct.

Suppose That Velocity and Output Are Constant, the Quantity Theory