An increase in the real interest rate will
A) increase the inflationary premium.
B) decrease the inflationary premium.
C) increase the price of current consumption relative to future consumption.
D) decrease the price of current consumption relative to future consumption.

Question

Quizplus · Accepted Answer

An increase in the real interest rate implies that the cost of borrowing money has increased. This leads to an increase in the price of current consumption relative to future consumption because individuals prefer to save money at a higher interest rate rather than spend it now. This shift in preference towards saving will increase demand for future consumption, which will drive up its price. This increase in the price of future consumption is known as the inflationary premium. Therefore, an increase in the real interest rate will not decrease the inflationary premium and it will not affect the price of current consumption.

An Increase in the Real Interest Rate Will