You agree to lend $1,000 for one year at a nominal interest rate of 10%.You anticipate that inflation will be 4% over that year.If inflation is instead 3% over that year,which of the following is true?
A)The real interest rate you earn on your money is lower than you expected.
B)The purchasing power of the money that will be repaid to you will be lower than you expected.
C)The person who borrowed the $1,000 will be worse off as a result of the unanticipated decrease in inflation.
D)The real interest rate you earn on your money will be negative.

Question

Quizplus · Accepted Answer

The real interest rate is calculated as the nominal interest rate minus the inflation rate. If inflation decreases from the expected 4% to 3%, the real interest rate increases, making the lender better off (earning more in real terms) and the borrower worse off, as they are paying back money that is worth more in terms of purchasing power.

You Agree to Lend $1,000 for One Year at a Nominal