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Inflationary expectations

29 April, 2015 - 15:37

According to the theory of rational expectations, people form an expectation of what will happen to inflation in the future. They then ensure that they offer or ask a nominal interest rate that means they have the appropriate real interest rate on their investment.

This is given by the formula:

i_n = i_r + p_e\,\!


i_n\,\! = offered nominal interest rate

i_r\,\! = desired real interest rate

p_e\,\! = inflationary expectations