If inflation had long been 4% and was therefore expected to continue, then it unexpectedly increased to 7% inflation:
A)the real interest rate on loans issued just before the change occurred would decrease by three percentage points.
B)the real interest rate on loans issued just before the change occurred would increase by three percentage points.
C)the real interest rate on loans issued just before the change occurred would not change.
D)none of the above.

Question

If inflation had long been 4% and was therefore expected to continue, then it unexpectedly increased to 7% inflation:
A)​the real interest rate on loans issued just before the change occurred would decrease by three percentage points.
B)​the real interest rate on loans issued just before the change occurred would increase by three percentage points.
C)​the real interest rate on loans issued just before the change occurred would not change.
D)​none of the above.

Quizplus · Accepted Answer

When inflation increases unexpectedly from 4% to 7%, the real interest rate on loans issued just before the change would decrease. This is because the real interest rate is calculated by subtracting the inflation rate from the nominal interest rate. If the nominal rate is fixed and inflation rises, the real interest rate falls.

If Inflation Had Long Been 4% and Was Therefore Expected