The Central Bank in Westeros engages in open market operations and sells bonds to the non-banking sector.
1-Assume that before they implement this contractionary monetary policy the nominal interest rate on savings accounts is 3% per year. If banks and
depositors expect an inflation rate of 1% per year, what is the expected real interest rate?
2-The contractionary monetary policy results in deflation of 2%. In the short
run, what is the effect of this unexpected deflation on depositors and
banks?
3- In the long run, what will happen to the nominal interest rate and the real
interest rate as a result of this deflation?
