Question

Suppose that you took out a student loan at a rate of​ 4.45%. Note that this rate is constant for the life of the loan.​ Next, suppose that at your first job after​ graduation, there are two​ possibilities: (i) the inflation rate is​ 2%, and your wages rise by​ 4% or​ (ii) the inflation rate is​ 3%, and your wages rise by​ 5%. (No, you certainly do not get a choice of inflation​ rates, but pretend that you can for the sake of exploring this important​ concept.) Briefly explain whether you would prefer the first or the second situation.

Answer 1

(ii) the inflation rate is​ 3%, and your wages rise by​ 5%

Step-by-step explanation:

As the inflation decreasethe value of money over-time

The student loan constant nominal-rate will make for a lower real-nterest on the loan. As more inflation bettter is to owe as the real burden of the liability is being halved by inflation. In the opposite side it is better not to loan at fixed rate under inflationaries economies as the capital will be destroyed.

Also, it is important the the second approach is preferable as we are given wages rise of 5% every year making them, increase higher than inflationhenceforth our real salaries increase in respect to debt in the long turn.