The ______ effect implies that nominal interest rates tend to be high when inflation is high and low when inflation is low?

Correct option is C

Correct Answer (c) Fisher effect

Explanation: The Fisher effect explains the relationship between nominal interest rates, real interest rates, and inflation. The Fisher effect correctly describes the relationship between inflation and nominal interest rates. As inflation increases, nominal rates rise to maintain the real interest rate.

Information Booster: According to this theory, nominal interest rates tend to be high when inflation is high and low when inflation is low. This is because the nominal interest rate is the sum of the real interest rate and expected inflation. When inflation rises, lenders demand a higher nominal interest rate to maintain their desired real return, which causes nominal rates to rise with inflation. Conversely, when inflation is low, nominal interest rates also tend to decrease.

Additional Knowledge:

• The Tobin effect refers to the effect of interest rates on the demand for assets, especially in the context of portfolio diversification. It is unrelated to the relationship between inflation and nominal interest rates.
• The Baumol effect focuses on the cost of holding cash and how individuals and firms manage cash balances. It does not explain the connection between inflation and nominal interest rates.
• The Patinkin effect is an economic theory that relates to the relationship between income, consumption, and liquidity in an economy. It does not explain the relationship between inflation and nominal interest rates.