Suppose the nominal interest rate on a one-year car loan is 8% and the inflation rate is expected to be 3% over the next year.Based on this information, we know:

Question

Quizplus · Accepted Answer

The ex ante real interest rate is calculated by subtracting the expected inflation rate from the nominal interest rate. Therefore, 8% - 3% = 5%. This means that the borrower will effectively only be making a 5% return on their loan after accounting for inflation. Option B is incorrect because both the lender and borrower are affected by the difference between nominal and real interest rates. Option C is incorrect because the borrower will still have to pay the full 8% nominal interest rate. Option D is incorrect because the ex post real interest rate cannot be known until after the end of the loan period and the actual inflation rate is known.

Suppose the Nominal Interest Rate on a One-Year Car Loan