Final answer:
The expected real interest rate on a loan with a 5% nominal interest rate and a −2% inflation rate (deflation) is 7%. The correct answer is E. 7%.
Step-by-step explanation:
The expected real interest rate on a loan is calculated by subtracting the expected inflation rate from the nominal interest rate. In this case, the nominal interest rate is 5% and the expected inflation rate is −2%, which is actually deflation.
We calculate the real interest rate as 5% - (−2%), which equals 7%. Therefore, the expected real interest rate on the loan is 7%.
Interest rates refer to the percentage of the principal amount charged by a lender to a borrower for the use of assets or money, typically expressed as an annual percentage. They play a crucial role in various financial aspects, such as loans, mortgages, savings accounts, and investments.
These rates can be influenced by several factors, including central bank policies, inflation rates, economic conditions, and market demand for borrowing. When interest rates are low, borrowing money becomes cheaper, encouraging spending and investment but potentially leading to inflation.