Which of the following is true about inflation and interest rates? (A) The higher the inflation rate, the higher the real interest rate. (B) If there is no actual or expected inflation, the nominal and real interest rates are equal

General
1

Which of the following is true about inflation and interest rates? (A) The higher the inflation rate, the higher the real interest rate. (B) If there is no actual or expected inflation, the nominal and real interest rates are equal. (C) If the economy is experiencing deflation, the nominal interest rate exceeds the real interest rate. (D) The higher the inflation rate, the lower the nominal interest rate. The nominal interest rate is the difference between the real interest rate and the expected inflation rate.

2

Which of the following is true about inflation and interest rates?

Answer:
In the context of inflation and interest rates, the following statements are true:

  • (A) The higher the inflation rate, the higher the real interest rate: This statement is false. In reality, when inflation rates rise, the real interest rate (nominal interest rate minus inflation rate) tends to decrease rather than increase. Lenders require a higher nominal interest rate to compensate for the loss of purchasing power due to inflation.

  • (B) If there is no actual or expected inflation, the nominal and real interest rates are equal: This statement is true. In a scenario without inflation, the real interest rate would indeed equal the nominal interest rate.

  • (C) If the economy is experiencing deflation, the nominal interest rate exceeds the real interest rate: This statement is false. During deflationary periods, the opposite is true. The real interest rate would be higher than the nominal interest rate.

  • (D) The higher the inflation rate, the lower the nominal interest rate. The nominal interest rate is the difference between the real interest rate and the expected inflation rate: This statement is partially true. As inflation rates rise, lenders often demand higher nominal interest rates to offset the effects of inflation. This relationship may vary depending on market conditions and expectations.