If inflation is expected by both borrowers and lenders, then we would expect
A)real rates to be higher than nominal rates of interest.
B)real rates to be equal to nominal rates of interest.
C)real rates to be lower than nominal rates of interest.
D)nominal rates of interest to be less than the expected inflation rate.

Question

Quizplus · Accepted Answer

If both borrowers and lenders expect inflation, lenders will demand higher nominal interest rates to account for the expected loss of purchasing power. However, borrowers will also be willing to pay higher nominal rates since they know that the money they receive today will be worth less in the future due to expected inflation. As a result, nominal interest rates will be higher than real interest rates, which account for inflation. Therefore, real rates will be lower than nominal rates of interest.

If Inflation Is Expected by Both Borrowers and Lenders, Then