If borrowers and lenders agree on a nominal interest rate and inflation turns out to be less than they had expected,
A)neither borrowers nor lenders will gain because the nominal interest rate has been fixed by contract.
B)the interest rate will rise.
C)borrowers will gain at the expense of lenders.
D)lenders will gain at the expense of borrowers.

Question

Quizplus · Accepted Answer

If inflation turns out to be less than expected, borrowers will benefit because they are still paying back the loan with dollars that are worth more than they had initially anticipated. However, lenders will lose out because they are receiving dollars that are worth less than they had anticipated. As a result, lenders would have been better off agreeing to a higher nominal interest rate to compensate for the possibility of lower-than-expected inflation.

If Borrowers and Lenders Agree on a Nominal Interest Rate