Question

the fisher effect implies that, to maintain a lender's purchasing power during periods of inflation, if the inflation rate increases by 3 percent,

select one:
a. the nominal interest rate should decrease by 3%
b. the real interest rate should increase increase by 3%
c. the real interest rate should decrease by 3%
d. the nominal interest interest rate should increase by 3%
e. none of the answers listed here is correct

Answer 1

Fisher effect describes that Real interest rate = Nominal interest rate –inflation rate. An increase in inflation reduces the real interest rate. Thus in order to compensate the lender from inflation, the nominal interest rate must increase to the extent of inflation rate. For example if the lenders fix nominal interest rate as 8% and inflation rate is 3%. The lenders loss by 3% from the 8% rate of interest. So to get 8% interest in real term, the nominal interest rate must increase to 11%.

Answer: d. the nominal interest rate should increase by 3%