Question

Suppose that a borrower and a lender agree on the nominal interest rate to be paid on a loan. Then inflation turns out to be lower than they both expected.
(1) True or False: The real interest rate on this loan is lower than expected.
The lender (2) gains/loses from this unexpected lower inflation, and the borrower (3) gains/loses under these circumstances.
Inflation during the 1970s was much higher than most people had expected when the decade began.
Homeowners who obtained fixed-rate mortgages during the 1960s (4) were harmed by/benefited from the unexpected higher inflation (with regard to their mortgages), and the banks that made the mortgage loans (5) were harmed/benfited?

Answer 1

Answer: 1. false , 2.gains , 3. losses , 4 harmed , 5 benefited

Explanation:

1. Real interest rate ≈ Nominal interest rate - Inflation rate

  Inflation rate has an inverse/negative relationship with Real interest rate,  an   increase in inflation rate will cause a decrease in real interest rate

2 if interest rate rises the lender gains because the borrower will now pay more interest on the loan

3. Borrower losses because more interest would need to be paid

4 harmed. when inflation rate increased in the 1970s interest rate fell drastically and borrowers could have paid lower interest if they were not on fixed interest rate

5 banks benefited they the interest rate on loans they made was not affected by the fall in the interest rate