Question

You borrow $10,000 today at a nominal rate of 5 percent; inflation for the past 10 years has been exactly 2 percent. Today, inflation instantly rises to 7 percent and stays that way for the duration of your loan. Based on the above information, this is an example of ceteris paribus (all else equal). True or False?

Answer 1

Answer: True

Explanation: You are better off. This is because the loan is being paid back with cash that has a lower buying power today, than it had when you first acquired the loan, or even before then.

The inflation rate increases but still stays below the nominal interest rate. This strengthens the value of the currency, lowering its purchasing strength, especially internationally. This means that less dollars will be needed today, to pay off ghetto loan, than 10 years later, when the loan was acquired.