Assume that the real rate of interest is 5 percent and a lender charges a nominal interest rate of 15 percent. If a borrower expects that the rate of inflation next year will be 10 percent and the actual rate of inflation next year is 10 percent,
A) the lender benefits from inflation, while the borrower loses from inflation.
B) the borrower benefits from inflation, while the lender loses from inflation.
C) neither the borrower nor the lender benefits from inflation.
D) both the borrower and the lender lose from inflation.

Question

Quizplus · Accepted Answer

Inflation is already priced in the nominal interest rate, so the lender is charging a higher nominal rate to account for expected inflation. However, if actual inflation matches expected inflation, there is no real increase in purchasing power for either the borrower or the lender. Therefore, neither the borrower nor the lender benefits from inflation.

Assume That the Real Rate of Interest Is 5 Percent