Question

The 1970s saw a period of high inflation in many industrialized countries including the united states. due to the increase in the rate of​ inflation, lenders, including credit card​ companies, revised their nominal interest rates upward. how is the rate of inflation related to the nominal interest rate that credit card companies​ charge, and why would lenders need to increase the nominal interest rate when the inflation rate​ increases?
a. the nominal rate of interest is the real rate of interest plus the rate of​ inflation; lenders need to raise the nominal rate when inflation increases to stabilize credit market activity.
b. the nominal rate of interest is the real rate of interest plus the rate of​ inflation; lenders need to raise the nominal rate when inflation increases to maintain their desired real return.
c. the nominal rate of interest and the inflation rate are inversely​ related; lenders need to raise the nominal rate when inflation increases to satisfy government regulations on lending practices.
d. the nominal rate of interest is the real rate of interest less the rate of​ inflation; lenders need to raise the nomin

Answer 1

Answer : b. the nominal rate of interest is the real rate of interest plus the rate of​ inflation; lenders need to raise the nominal rate when inflation increases to maintain their desired real return.

Explanation: Nominal rate = real rate + inflation . Suppose they had an real return of 4% when the inflation was 1% and they charged at credit card rate at 5%. Now if the inflation increases to 2%, the cannot continue to charge 5% since in that case their real return would only be 3%. Hence they will now have to charge 6% to still get their original real rate of 4%