Question

1. What is the value of the real interest rate in each of the following situations?

1. The nominal interest rate is 15%, and the expected inflation rate is 13%.
2. The nominal interest rate is 12%, and the expected inflation rate is 9%.
3. The nominal interest rate is 10%, and the expected inflation rate is 9%.
4. The nominal interest rate is 5%, and the expected inflation rate is 1%.
5. In which of the above situations would you prefer to be the lender? Why?
6. In which of the above situations would you prefer to be the borrower? Why?

Answer 1

Real interest rate = Nominal Interest rate - Expected Inflation.

A) Real interest rate = 15 - 13 = 2%

B) Real interest rate = 12 - 9 = 3%

C) Real interest rate = 10 - 9 = 1%

D) Real interest rate = 5 - 1 = 4 %

E) In situation D it will be beneficial to be a lender because the more the real interest rate more will be the value of money that will be received by lender in the future. The borrowers would be worse off under such situation.

F) In situation C it will be beneficial to be a borrower because the borrower benefits from a lower real interest rate—essentially, the money would be borrowed interest-free because of inflation.However, the lender that made the loan would receive less or no real return on the loan.