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Suppose that a borrower and lender agree on an interest rate for aloan, but the inflation turns out to be higher than they both hadexpected.
A) Will this cause the real interest rate on the loan to be higheror lower than expected? You should be able to relate this to theFisher Equation.
B) Does the borrower gain or lose from the unexpectedly highinflation? Explain. What about the lender?

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Prachi Dabas
Prachi DabasLv10
28 Sep 2019

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Related questions

Suppose I borrow $200,000 for one year at a fixed nominal interest rate of 7 percent.

(a) What is my nominal repayment next year?

(b) Suppose that at the time the loan was made, both the lender and I believed that the (ex-ante) rel interest rate on the loan would be two percent. Suppose the actual inflation rate over the life of the loan turns out to be 4 percent. What is the ex-post real interest rate? Does the inflation rate help me at the expense of the lender, or help the lender at my expense?

(c) Re-do question (b) assuming that the inflation rate turns out to be 5 percent and 6 percent.

(d) Given that the lender and I agreed that the ex-ante real interest rate should be 2 percent, what nominal interest rate would I have been charged if the lender and I had expected inflation over the life of the loan to be 10 percent? 3 percent? 0 percent?

(e) Inflation increased enexpectedly during the 1970s. Explain why this helped someone who bought a house using a 30-year mortgage with fixed nominal interest rates in 1965, but not someone who bought a house using a 30-year mortgage with a fixed nominal interest rate in 1980.

During the last year you lent money at a nominal rate of 6 percent.Actual inflation was 1 percent, but people had been expecting 1.5percent . This difference between actual and expectedinflation

A. transferred wealth from the borrower to you and caused youractual real interest rate to be more than 0.5 percentage pointshigher than what you had expected.
B. transferred wealth from you to the borrower and caused youractual real interest rate to be more than 0.5 percentage pointslower than what you had expected.
C. transferred wealth from the borrower to you and caused youractual real interest rate to be 0.5 percentage points higher thanwhat you had expected.
D. transferred wealth from you to the borrower and caused youractual real interest rate to be 0.5 percentage points lower thanwhat you had expected.

Instructions: Review and respond to at least two of your classmates' posts by sharing any ideas you may have about how households and businesses can protect themselves against inflation.

Please help with a response to the following:

The government tries to restrain inflation because it causes an unintended and undesirable redistribution of income and wealth€ (Amacher, Pate 2012). That is when a lender who is in the driver's seat when providing a loan to a person can charge a low-interest rate to entice people to borrow money at that low rate. Now if the Feds were to raise the interest rate even a quarter of a percent this could turn the tables from the lender over to the borrower. In the first scenario, the Lender will make a small profit over the long term with the low-interest rates. If the nation's interest rate increases, the value of the dollar goes down and the Lender ends up making less back than they loaned. This causes the redistribution of the income to favor the borrower.

Once inflation starts to happen it is a trickle-down effect on the consumer in the long run. Eventually, the consumer will start to pay inflated rates in some way through the goods and services they purchase. Those that are on fixed incomes will be adversely affected because as their income does not increase but the cost of goods does, they will have to find ways to cut their spending in order to make ends meet. This could be done without eating out as often, buying cheaper and fewer quality foods, or shopping at lower quality stores just to save the extra dollars that inflation has cost them. People who are on fixed incomes have to become more creative in order to still enjoy some qualities in life when times get tight.

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