Final answer:
When inflation is expected to steadily decrease, the term structure of interest rates is likely to be downward sloping. A state that borrowed money before an unexpected rise in inflation benefits because it repays the loan with less valuable dollars. Increases in inflation typically cause interest rates on adjustable-rate mortgages to rise.
Step-by-step explanation:
If inflation is expected to steadily decrease in the future, the term structure of interest rates will most likely be downward sloping. This is because when inflation is expected to decrease, lenders will anticipate lower inflation in the future and, therefore, lower interest rates on long-term loans compared to short-term loans, leading to a downward-sloping yield curve.
Regarding the other questions about the effects of inflation changes on various loans:
- If inflation rises unexpectedly by 5%, a state government that had recently borrowed money to pay for a new highway would benefit since they can repay their loans in dollars that are worth less than originally expected.
- An increase in inflation should cause the interest rate on an adjustable-rate mortgage to rise since these rates adjust to reflect changes in the market, which includes the effects of higher inflation.