Learning Path
Question & Answer1
Understand Question2
Review Options3
Learn Explanation4
Explore TopicChoose the Best Answer
A
It shows that nominal interest rates remain constant regardless of inflation.
B
It indicates that real interest rates increase when inflation rises, reducing purchasing power.
C
It demonstrates that purchasing power is unaffected by changes in interest rates.
D
It suggests that central banks should lower interest rates to combat inflation.
Understanding the Answer
Let's break down why this is correct
Answer
The Fisher equation helps us understand the relationship between interest rates, inflation, and the purchasing power of money. It states that the nominal interest rate is equal to the real interest rate plus the expected inflation rate. When inflation is high, it erodes the purchasing power of money, meaning that each dollar buys less than before. For example, if a central bank increases interest rates to combat inflation, it can help maintain the value of money, allowing people to buy more with the same amount of cash. Therefore, the Fisher equation highlights how central banks can influence economic stability by managing interest rates in response to inflation.
Detailed Explanation
When inflation goes up, real interest rates can increase. Other options are incorrect because Some might think interest rates don't change with inflation; It's a common mistake to believe interest rates don't affect purchasing power.
Key Concepts
Fisher equation
Purchasing power
Central bank policy
Topic
Real Interest Rates and Inflation
Difficulty
hard level question
Cognitive Level
understand
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