Suppose expected inflation was 2% and actual inflation was 4%. Then the ex post
ID: 1189372 • Letter: S
Question
Suppose expected inflation was 2% and actual inflation was 4%. Then the ex post real interest rate was ---- than the ex ante real interest rate and there was a redistribution of wealth from ----.
a higher; borrowers to lenders
b higher; lenders to borrowers
c lower; borrowers to lenders
d lower; lenders to borrowers
Suppose that, in the short run, the price level is sticky (fixed) but nominal interest rates adjust to achieve equilibrium in the money market. According to the liquidity preference theory, if the central bank increases the money supply, then short-term nominal interest rates
a rise.
b fall.
c remain unchanged.
All else equal, if the ratio of reserves to deposits increases, the money supply
a increases
b decreases
c remains the same
Depreciation is tax-deductible but based on the historical cost of capital. If inflation is positive, then the corporate income tax ---- investment.
a encourages
b discourages
c has no effect on
If the price index for capital goods is the same as the price index for other goods, an index of the real cost of capital, in the absence of taxes, is the
a nominal interest rate plus the depreciation rate.
b real interest rate plus the depreciation rate.
c purchase price of a capital good multiplied by the sum of the nominal interest rate plus the depreciation rate.
d purchase price of a capital good multiplied by the sum of the real interest rate plus the depreciation rate.
Explanation / Answer
1. Suppose expected inflation was 2% and actual inflation was 4%. Then the ex post real interest rate was lower than the ex ante real interest rate and there was a redistribution of wealth from lenders to borrowers.
This is because ex post real interest rate (Nominal Interest Rate - Actual Inflation) is 2% lesser than the ex ante real interest as ex post real interest (Nominal Interest Rate - Expected Inflation Rate) takes into consideration actual inflation rate while ex ante takes expected inflation rate into consideration. Thus, when actual real nterest rate is lesser than the expected real interest, borrrowers will be willing to borrow more, thereby leading to redistribution of wealth from lenders to borrowers.
3. All else equal, if the ratio of reserves to deposits increases, the money supply decreases.
This is because, Money Supply = Monetary Base * Money Multiplier
Where,
Monetary Multiplier = 1/Reserve Ration
If reserve ratio increases, money multiplier decreases. A decrease in money multiplier will thus lead to decrease in money supply with same monetary base as before.