If borrowers and lenders anticipate that the rate of inflation will be 5%, but instead it turns out to be 3%, which of the following is likely to occur?
A)The real interest rate is higher than expected.
B)Lenders wish that they had made fewer loans.
C)Borrowers wish that they had borrowed more money.
D)Insufficient loans will have been made by lenders to maintain profit levels.

Question

Quizplus · Accepted Answer

The real interest rate is the nominal interest rate minus the rate of inflation. If inflation turns out to be lower than anticipated, then the real interest rate will be higher than expected. This means that lenders will be earning a higher return than they had anticipated, while borrowers will be paying a higher interest rate than they had expected. Therefore, borrowers are unlikely to wish that they had borrowed more money, and lenders are unlikely to wish that they had made fewer loans. Insufficient loans will not be made by lenders to maintain profit levels, as the higher real interest rate will make lending more attractive for lenders.

If Borrowers and Lenders Anticipate That the Rate of Inflation