"What is the Fisher effect? Question 54 options: a) the tendency of nominal interest rates to fall with higher expected inflation rates b) the tendency of nominal interest rates to rise with higher expected inflation rates c) the tendency of real interest rates to fall with higher expected inflation rates d) the tendency of real interest rates to rise with higher expected inflation rates"

c) the tendency of real interest rates to fall with higher expected inflation rates

Explanation:

The fisher effect establishes the relationship between real interest rates, nominal interest rates, and inflation rates, with the following formula:

Real Interest Rate = Nominal Interest Rate - Inflation Rate

If the inflation rate is high, the real interest rate falls, and if the inflation rate is sufficiently high, the real interest rate becomes negative. For example, if the nominal interest rate is 3%, and the inflation rate is 4%, then, the real interest rate is:

Real Interest Rate = 3% - 4%

                              = -1%

Which means that the real interest rete is 1% less than inflation (it did not beat inflation, and the investor is losing purchasing power).

From this explanation we can conclud that if investor expect a very high inflation rate, the real interest rate will fall, and viceversa.

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