Question

Suppose that a bank expects inflation to be 2 percent and charges borrowers an interest rate

of 4 percent accordingly. Now suppose that inflation is actually 2 percent. In this case, inflation:

                A)    does not affect the distribution of income.

                B)    redistributes income from the bank to the bank's borrowers.

                C)    redistributes income from the bank's borrowers to the bank.

                D)    redistributes income from the bank to the bank's lenders.

Answer 1

Since expected inflation and actual inflation is positively correlated. So when there is a decrease in the expected inflation rate, then actual inflation rate will also increase.

As the information has been provided that a bank expects inflation to be 2 percent and charges borrowers an interest rate of 4 percent accordingly. Now suppose that inflation is actually 2 percent. In this case, inflation does not affect the distribution of income.

This is because the expected inflation rate and actual inflation rate are same and it is 2 % and therefore there will be no change in the distribution of income.

Hence option A is the correct answer.