Suppose that at the beginning of a loan contract, the real interest rate is 4% and expected inflation is currently 6%.If actual inflation turns out to be 7% over the loan contract period, then
A)borrowers gain 1% of the loan value.
B)lenders gain 1% of the loan value.
C)borrowers lose 3% of the loan value.
D)lenders gain 3% of the loan value.
E)lenders gain 2% of the loan value.

Question

Quizplus · Accepted Answer

When actual inflation is higher than expected (7% instead of 6%), the real value of the money repaid is less than anticipated. This benefits borrowers, as they pay back less in real terms than expected. The difference in inflation (1%) represents the gain for borrowers.

Suppose That at the Beginning of a Loan Contract, the Real