1. What factors determine the real rate of interest? The real rate of interest is determined by: (a) individual time preference for consumption, and (b) the return that firms expect to earn on their real capital investments. In equilibrium, the real rate of interest is determined when desired saving equals desired investment. 2. If the money supply is increased, what happens to the level of interest rates? An increase in the money supply shifts the supply of loanable funds to the right, lowering interest rates. 3. What is the "Fisher effect"? How does it affect the nominal rate of interest? The Fisher effect, espoused by Irving Fisher, theorizes that expected inflation is embodied in current nominal interest rates. Assuming the ability to forecast expected inflation, nominal rates should vary directly with expected inflation. 4. The 1 year real rate of interest is currently estimated to be 4%. The current annual rate of inflation is 6%, and market forecasts expect the annual rate of inflation to be
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