Consider the Fisher equation, but add inflation () to both sides. The nominal interest rate is now determined by the real interest rate and inflation.

i = r +

Now you can set the nominal interest rate for a loan when you expect inflation to be a certain rate. If you're loaning someone money, this is an important relationship to understand. If you expect inflation to be a high 7% over the year, then you should also set a high nominal interest rate for the borrower. This is because you know that inflation erodes the value of money over time and you (the lender) must be compensated for that. Does this suggest a positive or negative relationship, or is there no relationship bank interest rates and inflation? Explain.