One explanation for the impact of expected price changes on the level of output is that an increase in expected deflation ______ the nominal interest rate and ______ the real interest rate, so that investment spending declines.
A) lowers; raises
B) raises; lowers
C) raises; raises
D) lowers; lowers

Question

Quizplus · Accepted Answer

An increase in expected deflation lowers the nominal interest rate because central banks may lower rates to stimulate the economy. However, it raises the real interest rate because the real interest rate is adjusted for inflation, and deflation increases the value of money over time, making borrowing more expensive in real terms. This discourages investment spending.

One Explanation for the Impact of Expected Price Changes on the Level