Explain the Fisher effect. In the context of the long-run money market equilibrium suppose that the...

Explain the Fisher effect. In the context of the long-run money market equilibrium suppose that the central bank announces today that money supply is going to increase in the future. Assume that the announcement is credible. Explain in detail what should happen to the aggregate price level today.

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Expert Solution

the fisher effect states that real interest rate is the nomonal interest rate less inflation so real interest rate falls as inflation increases and vice versa. It’s important that the real interest rate be positive so that a lender or investor knows he’s beating inflation. if the real interest rate is less than zero then the rate being charged on a loan or paid on a savings account is not beating inflation.

if the central bank announces today that money supply is going to increase in the future its a sign that there will be a increase in inflation rate in the future as we know increased money supply increases inflation. so an expected rise in price in the near future will make people to demand more good and services today and hoard it for the future. so the increased demand today wil push the price level high and the aggregate price level today will increase as well.

Rahul Sunny answered 10 months ago

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