Question

In each of the following scenarios explain who is better off (i.e. the borrower or lender) when a borrower borrows $200 from a lender (assume the loan is always made).

a. Inflation is 5% and interest charged is 4%

b. Inflation is 3% and the interest charged is 4%

c. Inflation is -2% and the interest charged is 0%

Answer 1

Answer .) Remember that loss of lender(borrower) is gain of borrower(lender).

a.) Note lender charging interest rate lower than inflation rate therefore it's a clear loss to lender and hence borrower is better off.

b.) Interest rate charged is higher than inflation rate therefore lender is better off.

c.) Lender is better off because according to rule of real interest rate ,

Real interest rate = nominal interest rate - inflation rate

= 0 - (-2)

Real interest rate = 2

Therefore lender earning a positive real interest rate.