Expected inflation and the real rate of interest : A Note

This paper derives an alternative explanation for the Mundell effect in the context of a state preference framework. In contrast to the real cash balance effect discussed by Mundell, the arrival of new information concerning the future course of economic events is shown to simultaneously affect both the real rate of interest and the expected rate of inflation. A negative relation between changes in expected inflation and the real rate of interest is shown to occur in spite of the fact that investors in this model hold no cash balances.