Question

Suppose the announcement of a new head of the central bank, with a reputation as a tough inflation fighter, reduces expected inflation by 2.0 percentage points. According to the Fisher effect, what is the new nominal interest rate

Answer 1

The new nominal interest rate will also reduce by 2.0 percentage points in line with the reduction in the expected inflation.

Explanation:

According to the Fisher effect, nominal interest rate = real interest rate + expected rate of inflation. From this formula, any reduction in the expected rate of inflation will also have equal effect on the nominal interest rate. The Fisher effect shows that any monetary supply influence on the inflation rate also affects the nominal interest rate equally.