Answer to Question 1:

Higher nominal interest rates lead eventually to higher actual and expected inflation rates.

True or False?


The answer is false. The statement gets it backwards. Higher inflation rates will eventually lead to higher expected inflation rates which will in turn cause asset holders to demand higher nominal interest rates to compensate for the higher expected rates of inflation.

Higher expected inflation rates do not affect contracted real interest rates. Nor do they affect realized real interest rates if expectations about the inflation rate turn out to be correct. Contracted real interest rates are set to maintain consistency with the real rate of interest that can be achieved by adding to the real capital stock. The "inflation premium" is added to the contracted real interest rate. Realized real interest rates will differ from contracted real rates if wealth owners' expectations turn out to be incorrect and the inflation premium contracted for turns out to be wrong.

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