Question

(Show all correct answers.) According to the long-run macroeconomic theory of nominal variables discussed in class, the price level increases if:

a. the quantity of money in the economy increases

b. the growth rate of the quantity of money in the economy increases

c. there is a cut in taxes

d. there is an increase in government spending

(Show all correct answers.) Which of the following statements about the Fisher effect are correct?

a. An x percent increase in inflation causes an x percent increase in the nominal interest rate.

b. Data on U.S. inflation rates and nominal interest rates over time provide support for the Fisher effect.

c. International data on inflation rates and nominal interest rates provide support for the Fisher effect.

d. U.S. data from the late nineteenth and early twentieth centuries shows that nominal interest rates did not respond to rising inflation. Economists think that the inflation during this era was a “surprise” that was not in step with expected inflation and, therefore, had no effect on nominal interest rates.

Answer 1

1) Solution: the growth rate of the quantity of money in the economy increases

Explanation: In the long run according to classical macroeconomic theory monetary growth affects nominal but not real variables

　

2) Solution: An x percent increase in inflation causes an x percent increase in the nominal interest rate

Explanation: According to the Fisher equation the nominal interest rate equals the sum of inflation and the real interest rate. Because the real interest rate is computed by investment and savings, thus an x percent increase in the inflation rate will will lead to a x percent rise in the nominal interest rate.