Question

Suppose that the nominal interest rate is 6% and the expected inflation rate is 2%. If banks and the public expect the inflation rate to increase to 4% a Banks will keep their nominal interest rates at 6% b Banks will increase their nominal interest rates c Banks will lend more money to borrowers d The real interest rate should increase also

Answer 1

Answer:

The answer is: B) Banks will increase their nominal interest rates

Explanation:

If the nominal interest rate is 6% and the inflation rate is 2%, then the real interest rate will be 4%. If the inflation rate is expected to increase to 4% (a 2% increase), banks will usually increase their nominal interest rate in the same proportion (a 2% increase) so the new nominal interest rate would be 8%. This is done in order to keep the real interest rate stable.