Assume Canadian consumers expect future income to rise. Starting from the natural rate of output, explain with a graph how this expectation will affect the interest rate, inflation rate and real GDP in the short-run. Also show and explain how the bank of Canada can help take the inflation rate back to its original target?

Q: What happens to the value of nominal interest rate in the economy when the Federal Reserve buys…

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Q: How is the interest rate affected by an increase in expected inflation

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A: the short-run effect on production and the long-run effect on inflation

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Q: Using equation of exchange explain what should central banks do to avoid long run inflation?

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Inflation and Purchasing Power Theory

In economic terms, Inflation refers to the increase in the costs of various commodities which are used in daily lifestyle like food, clothes, transport, etc. over a specific time. It may lead to a fall in the purchasing power of the people and also affects the exchange rate of the currency because of the price increase. As the purchasing power falls the unit of the currency in the economy falls. When the prices of the commodities are decreased, then the purchasing power of the consumers will rise, then it will lead to deflation and changes the currency of the base economy to that of the foreign economy which will lead to change in exchange rates.