Question

According to the Fisher effect, if a lender and a borrower would agree on an interest rate of 8 percent when no inflation is expected, they should set a rate of _______ when an inflation rate of 3 percent is expected.

Answer 1

Answer:

5%

Step-by-step explanation:

According to fisher equation

Nominal rate = Real rate + Inflation

N = R + I

N is calculated when there is no inflation and for the current year = 8%

The Real rate is calculated from the base year

Real rate is consider "Inflation factor" and R is unknown

Inflation rate (I) = 3%

Hence, N = R + I

8 = R + 3

R = 8 - 3

R = 5%