Ms. Smith borrowed $1000 from her bank for one year at an interest rate of 10 percent per year. During that year the price level went up by 15 percent. Who loses and who gains because of the unexpected inflation?

Question

Quizplus · Accepted Answer

Ms. Smith gains because the real value of the money she pays back is less due to inflation. The bank loses because the real value of the money it receives back is less than expected. The 10 percent interest does not keep up with the 15 percent inflation, effectively making the real interest rate negative for the lender.

Ms Smith Borrowed $1000 from Her Bank for One Year