Question

if the nominal interst rate on mortagage loan rise from 7% to 14% but the expected rate rises from2% to 12% are people more less likely to buy houses borrow money ? why

Answer 1

The real intereste rate, nominal interest rate and the expected rate of inflation bears a particular relationship given by:

Nominal interest rate= Real interest rate + Expected inflation rate.

Real interest rate= Nominal interest rate - Expected inflation rate

Previously,

The nominal interest rate was 7%, and the expected rate of inflation was 2%

Thus the real interest rate was= 7-2 = 5%

Now,

The nominal interest rate is 14%, and the expected rate of inflation increases to 12%

Thus, the real intrest rate becomes= (14- 12)= 2%

It is apparent that the real interest rate has now reduced. This implies that less money is now to be given as interest upon loans. This makes borrowing of money cheaper. This gives incentives to borrowing and people are now more likely to borrow money for houses as the real interest rate has decreased from 5% to 2%.