Question

Briefly explain whether the following statement is true or false:

“Assuming the real interest rate is fixed, expectations of higher inflation due to faster money-supply growth will not have any effect on the level of real money balances.”

Please answer elaborately with proper reasoning, graphs and equations. Also include a policy example.

Answer 1

Assuming the real interest rate is fixed expectations of higher inflation due to faster money supply growth will not have any effect on the level of real money balance.

The above statement is 'true'.
The Fisher Effect explains that the real interest rate equals the nominal interest rate minus the expected inflation rate. Therefore, real interest rates decrease as inflation increases, so if the real interest rate is fixed, the expectations of higher inflation will have not any effect on the level of real money balance.
Real money balances is the real value of the amount of money held by a person, household or firm or the amount in circulation in the economy or the real value of money balances, their purchasing power in terms of goods.