If debt contracts are of fairly long maturity, then an unanticipated decline in the aggregate price level results in ________.
A) a decline in a firm's net worth
B) an increase in a firm's net worth
C) a decrease in adverse selection and moral hazard
D) an increase in willingness to lend

Question

Quizplus · Accepted Answer

If there is an unanticipated decline in the aggregate price level, it leads to deflation which increases the real value of debt obligations, making them more difficult to repay. This results in a decline in a firm's net worth as it becomes harder for the firm to meet its debt obligations, and the value of its assets may also decline due to the deflation.

If Debt Contracts Are of Fairly Long Maturity, Then an Unanticipated