Suppose people expect there to be a substantial increase in the rate of inflation over the next few years. Which of the following would you predict?

Question

Quizplus · Accepted Answer

When people expect an increase in inflation, lenders will demand a higher nominal interest rate to compensate for the expected loss in purchasing power of the money they will be paid back with. Borrowers, in turn, will be willing to pay this higher nominal interest rate in order to secure the funds they need. Therefore, we can expect a higher nominal interest rate in response to expectations of higher inflation.

Suppose People Expect There to Be a Substantial Increase in the Rate