If expected inflation rises, monetary policy ________. A) is ...

[pragya sharda]

If expected inflation rises, monetary policy ________.
 
  A) is rendered ineffective
  B) must be tightened, to prevent further increases in inflation and expected inflation
  C) will prevent any increase in the real interest rate
  D) is designed to increase the nominal interest rate by more than the increase in expected inflation
  E) none of the above

Question 2

How does a decline in the real interest rate cause an increase in investment?
 
  What will be an ideal response?

[alexanderhamilton]

Answer to Question 1

D

Answer to Question 2

The real interest rate is the reward for saving and the cost of borrowing. A reduced interest rate will encourage more spending on both consumption and investment. Business firms, in particular, will use available funds to purchase new capital goods from which to generate future income, instead of holding financial assets (e.g., government bonds) that offer a reduced income. The purchase of capital goods will be financed by borrowing, as well, so long as the expected income from use of the capital goods exceeds the (reduced) cost of borrowing.

[pragya sharda]

Thank you

[alexanderhamilton]

No problemo