Suppose you are a borrower and you expect inflation to be 6 percent over the next year because inflation was 6 percent in the last year. If you do not want to pay more than 2 percent in real terms for any loan you take out, you will not borrow if the interest rate is greater than:

Question

Quizplus · Accepted Answer

The real interest rate can be approximated by subtracting the expected inflation rate from the nominal interest rate. If you expect inflation to be 6% and do not want to pay more than 2% in real terms, the maximum nominal interest rate you would accept is 8% (2% real interest + 6% inflation = 8% nominal interest).

Suppose You Are a Borrower and You Expect Inflation to Be