6. The Fisher effect and the cost of unexpected inflationSuppose t.pdf

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6. The Fisher effect and the cost of unexpected inflation Suppose the nominal interest rate on savings accounts is 9% per year, and both actual and expected inflation are equal to 3%. Complete the first row of the table by filling in the expected real interest rate and the actual real interest rate before any change in the money supply. Now suppose the Fed unexpectedly increases the growth rate of the money supply, causing the inflation rate to rise unexpectedly from 3% to 6% per year. Complete the second row of the table by filling in the expected and actual real interest rates on savings accounts immediately after the increase in the money supply (MS). The unanticipated change in inflation arbitrarily harms(banks/depositors). Now consider the long-run impact of the change in money growth and inflation. According to the Fisher effect, as expectations adjust to the new, higher inflation rate, the nominal interest rate will (rise/fall) to_____%per year. Time PeriodNominal Interest RateExpected InflationActual InflationExpected Real Interest RateActual Real Interest Rate(Percent)(Percent)(Percent)(Percent)(Percent)Before increase in MS933 ______ _______Immediately after increase in MS936 ______ ________ Solution we know that fishers equation of inflation measures the actual and nominal rate of interest rate. Irving fisher explains this is based on the formula: real interest rate= nominal interest rate-actual or expected rate of inflation the unanticipated change in inflation arbitrarily harms- Depositors Nominal interest rate will rise 12% per yeartime periodsexpected real interest rateactual real interest ratebefore increase in money supply9-3=6%9-3=6%immediatly after increase in MS9- 3=6%9-6=3%.

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