1. Which of the following statements is correct? a. A constant rate of increase

Question

1. Which of the following statements is correct?

a. A constant rate of increase in the price level, P, will lead to a continuous rise in the nominal interest rate,i.

b. A continuous increse in the inflation rate, pi, will lead to a continuous rise in the nominal interest rate, i.

2. Define the real interest rate,r. Why does it differ from the nominal interest rate, i, in the presence of inflation?

3. Why does the actual real interest rate, r, generally differ from the expected real interest rate, r^e? How does this relation depend on whether bonds prescribe the nominal or real interest rate?

4. Why does the real interest rate, not the nominal interest rate, have intertemporal-substitution effects on consumption and saving? Does the same result apply for intertemporal substitution of labor supply?

Explanation / Answer

B. is true as constant rate of increase in price level P is inflation i.e. inflation is constant and so will be nominal interest rate as i = r+pi where i is nominal interest rate, r is real interest rate and pi is inflation so if pi keeps on increasing i will also keep on increasing.

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