The key reason that expected inflation can distort financial decisions is that
A)lenders pay taxes on nominal rather than real returns.
B)lenders have an easier time calculating expected inflation than do borrowers.
C)expected inflation reduces the real value of the national debt.
D)expected inflation results in substantial menu costs.

Question

Quizplus · Accepted Answer

Lenders pay taxes on nominal returns, which means their after-tax real returns will be decreased if inflation is higher than expected. Borrowers, on the other hand, benefit from higher inflation as they are repaying their loans with less valuable dollars. This can lead to distorted financial decisions as lenders may be less willing to lend and borrowers may borrow more than they otherwise would if inflation expectations were accurately reflected in interest rates.

The Key Reason That Expected Inflation Can Distort Financial Decisions