Which of the following increases the real interest rate?
A) a decrease in the nominal interest rate, holding the inflation rate constant
B) an increase in both the nominal interest rate and the inflation rate by the same percentage points
C) a decrease in the inflation rate, holding the nominal interest rate constant
D) a decrease in both the nominal interest rate and the inflation rate by the same percentage points

Question

Quizplus · Accepted Answer

According to the Fisher effect, the real interest rate equals the nominal interest rate minus the inflation rate. Therefore, if the inflation rate decreases while holding the nominal interest rate constant, the real interest rate will increase. Option A and D are incorrect because a decrease in the nominal interest rate or both nominal and inflation rates by the same percentage points will decrease the real interest rate. Option B is incorrect because an increase in both nominal and inflation rates by the same percentage points will not change the real interest rate as the Fisher effect predicts that the real interest rate remains constant.

Which of the Following Increases the Real Interest Rate