Question

The Fisher Effect has all of the following components, except: (A) Compensation for Inflation on Investment Earned(B) Compensation for Inflation of Original Investment(C) Real Rate on the Investment(D) Expected Rate of Return

Answer 1

Answer:

D) Expected Rate of Return

Explanation:

The Fisher effect states that in response to a change in the money supply, the nominal interest rate changes hand-in-hand with changes in the inflation rate in the long run. It does not specify any component to derive expected rate of return on the investment. Take for instance, a monetary policy were to cause an inflation to increase by 5% points, the nominal interest rate in the economy would consequently increase by 5% points too.

Fisher effects phenomenon effects most In the long run than in the short run. In essence, if nominal interest were set based on expected level of inflation. if there is an unexpected inflation, real interest rates can drop in the short run because to some degree the nominal interest rates are fixed. However, overtime, there will be an adjustment with the nominal interest rate to equal with the new expectation of inflation but the expected rate for the return is not a component stated or can be drawn from the Fisher Effects theory.