Question

According to the Fisher equation, if the expected inflation rate is less than the actual inflation rate, then the actual rate of return will be:
A.
lower than the equilibrium interest rate.

B.
the same as the equilibrium interest rate.

C.
higher or lower than the equilibrium interest rate, depending on the degree of money illusion.

D.
higher than the equilibrium interest rate.

Answer 1

Answer:

D. higher than the equilibrium interest rate.

Explanation:

The Fisher equation at equilibrium ; i = r + τe helps you to answer this question whereby;

i = nominal interest rate

r = real interest rate

τe = expected inflation rate

If we re-write it beginning with real interest rate ; r = i - τe .

So, considering the above equation, if the actual inflation rate turns out to be lower than expected , we will have a lower τe and the difference  (i - τe) will be bigger making the real interest rate higher than equilibrium.