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9. Problems and Applications Q9 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. True or False: The real interest rate on this loan is higher than expected. True False The lender from this unexpected lower inflation, and the borrower 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 the unexpected higher inflation (with regard to their mortgages), and the banks that made the mortgage loans . g

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Answer:

The real interest rate on this loan is higher than expected. ⇒ TRUE

The lender from this unexpected lower inflation, and the borrower under these circumstances. ⇒ THIS QUESTION IS INCOMPLETE, THE LENDER WILL BENEFIT (HIGHER REAL INTEREST RATE) WHILE THE BORROWER LOSES.

Inflation during the 1970s INFLATION was much higher than most people had expected when the decade began. Homeowners who obtained fixed-rate mortgages during the 1960s BENEFITED FROM the unexpected higher inflation (with regard to their mortgages), and the banks that made the mortgage loans LOST.

Explanation:

real interest rate = nominal interest rate - inflation rate

If nominal interest rate remains stable, but inflation rate decreases, then the real interest rate will increase. On the other hand, if nominal interest rate remains stable but the inflation rate increases, then real interest rate will decrease (and sometimes will even turn negative).

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