Multiple Choice
Which of the following is an inflation-adjusted return on a loan or bond (i.e., the real interest rate) according to the Fisher relationship?
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11. Unemployment and Inflation
Nominal Interest, Real Interest, and the Fisher Equation
Multiple Choice
According to the Fisher equation, if expected inflation rises while the real interest rate remains unchanged, how will nominal bond yields typically change?
A
They fall because higher inflation lowers the nominal return lenders require.
B
They remain unchanged because inflation affects real returns but not nominal yields.
C
They rise by approximately the same amount as the increase in expected inflation.
D
They rise only if the real interest rate also rises by the same amount.
Verified step by step guidance1
Recall the Fisher equation, which relates nominal interest rates (\(i\)), real interest rates (\(r\)), and expected inflation (\(\pi^e\)):
\[i = r + \pi^e\]
Understand that the real interest rate (\(r\)) is assumed to remain constant in this problem, so any change in expected inflation (\(\pi^e\)) will directly affect the nominal interest rate (\(i\)).
Since nominal bond yields reflect the nominal interest rate, an increase in expected inflation will cause nominal bond yields to rise by approximately the same amount, assuming the real interest rate does not change.
Therefore, the correct interpretation is that nominal bond yields rise roughly in line with the increase in expected inflation, consistent with the Fisher equation.
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