A bank makes a loan for one year. The nominal annual interest rate is 7.5%. The real rate is 4%. Over the course of the year, overall prices increase by 4%. This rate of inflation hurt the _____ because the actual rate of inflation was _____ than the anticipated rate.

Question

Quizplus · Accepted Answer

The lender is hurt because the actual rate of inflation (4%) was higher than the anticipated real rate of return (4% - assuming the anticipated inflation was factored into the nominal rate to arrive at the real rate), reducing the purchasing power of the money when it's paid back.

A Bank Makes a Loan for One Year