Suppose you are a lender and you expect inflation to be 4 percent over the next year because inflation was 4 percent in the last year. If you want to earn a real return of 2 percent on any loans you make, you will set the interest rate on your loans equal to:

Question

Quizplus · Accepted Answer

To earn a real return of 2 percent when expecting inflation to be 4 percent, you would set the interest rate at 6 percent. This is because the nominal interest rate is the sum of the real interest rate and the expected inflation rate (Fisher equation), so 2% (real return) + 4% (inflation) = 6%.

Suppose You Are a Lender and You Expect Inflation to Be