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Suppose Thad loans Alyssa $1000 for one year at 10% nominal interest rate (i = 10%)....

Suppose Thad loans Alyssa $1000 for one year at 10% nominal interest rate (i = 10%). The price of a cup of coffee is $2 and everyone expects it to cost $2.04 next year (π e = 2%). At the end of the year, Alyssa will repay $1100.

a) Based on their expectations, how many cups of coffee are given up by Thad today? How many does he expect to be able to consume in one year?

b) What is the real interest rate being paid by Alyssa?

c) Suppose that the actual inflation turned about to be 6% (higher than expected). What happens to the actual (ex-post) real interest rate?

d) Given this higher than expected inflation, how many cups of coffee can Thad consume in one year?

e) How does unexpected inflation affect the borrower?

f) How does unexpected inflation affect the lender?

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