Question

Suppose the fixed interest rate on a loan is​ 5.75% and the rate of inflation is expected to be​ 4.25%. The real interest rate is​ 1.5%. Suppose now that instead of​ 4.25%, the inflation rate unexpectedly reaches​ 5.5%. Who gains and who loses from this unanticipated​ inflation? ​

(Mark all that​ apply.)


A. Lenders gain from a lower real interest rate.


B. Borrowers gain from a lower real interest rate.


C. Borrowers lose from a lower real interest rate.


D. Lenders lose from a lower real interest rate.

Answer 1

• Option B: Borrowers gain from a lower real interest rate.
• Option D: Lenders lose from a lower real interest rate.

Explanation:

Lenders lose their real interest rates at a lower level. Creditors benefit from a lower rate of interest.

Inflation occurs spontaneously because people understand that inflation only happens when price levels increase widely. Several persons, for example, borrowers who have a decreased buying power, are left exposed in this scenario.

Unanticipated inflation harmed borrowers even though the money they receive is less purchasing-powerful than the money that they lend. Creditors benefit from unpredictable inflation since the money they repay is less than the amount they have lent.