   Chapter 12, Problem 5CQQ

Chapter
Section
Textbook Problem

According to the Quantity theory of money and the Fisher effect, if the central bank increases the rate of money growth.a. inflation and the nominal interest rate both increase.b. inflation and the real interest rate both increase.c. the nominal interest rate and the real interest rate both increase.d. inflation, the real interest rate, and the nominal interest rate all increase.

To determine

Money growth, quantity theory of money, and Fisher effect.

Explanation

Option (a):

If the central bank increases the growth of money, the quantity of money increases. According to the quantity theory of money, an increase in the quantity of money causes a proportional increase in the price level (inflation) and according to the Fisher effect, an increase in the inflation rate raises the nominal interest rate by the same amount that the inflation rate increases. Thus, option ‘a’ is correct.

Option (b):

According to the Fisher effect, an increase in the inflation rate raises the nominal interest rate with no effect on the real interest rate...

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