The Fisher equation shows a relationship between nominal and real interest rates r=i-?. Draw a graph...

The Fisher equation shows a relationship between nominal and real interest rates r=i-?. Draw a graph consisting of AD, SRAS, and LRAS and mark the long-run equilibrium. On the same graph, show what happens if a very large shock to AD that causes inflation to become negative (deflation). Now suppose that a scenario occurs where nominal interest rates are zero. According to the fisher equation, what would the real interest rate be in this case? In what direction would real interest rates move if there is deflation? What would this do to spending in the economy? Do you see any solutions to this problem?

Expert Solution

Rahul Sunny answered 2 years ago

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