When the public expects inflation, real and nominal interest rates will differ because inflation needs to be accounted for in calculating the real return from lending and borrowing.

Question

Quizplus · Accepted Answer

This statement is true. Real interest rates take into account inflation, while nominal interest rates do not. If inflation is expected, lenders will charge a higher nominal interest rate to account for the decrease in purchasing power the borrower will experience due to inflation. Borrowers, in turn, will demand a higher nominal interest rate to compensate for the greater costs they will have to bear as a result of inflation. Real interest rates reflect the true cost of borrowing or the true reward for lending after accounting for inflation.

When the Public Expects Inflation, Real and Nominal Interest Rates