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.
Time Period Nominal Interest Rate Expected Inflation Actual Inflation Expected Real Interest Rate Actual Real Interest Rate
(Percent) (Percent) (Percent) (Percent) (Percent)
Before increase in MS 9 3 3
Immediately after increase
in MS 9 3 6
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.