Suppose that in the absence of inflation, a bank is willing to make a mortgage loan for $100,000 at an annual interest rate of 7 percent. If the bank expected the inflation rate to be 4 percent, however, the bank would charge the borrower an annual interest rate of
A) 3 percent
B) 6 percent
C) 9 percent
D) 11 percent

Question

Quizplus · Accepted Answer

The real interest rate is the nominal interest rate minus the expected inflation rate. In this case, the real interest rate is 7% - 4% = 3%. The bank would charge the borrower an annual interest rate of 3% + 4% = 7%.

Suppose That in the Absence of Inflation, a Bank Is