Question

How might a lender who anticipate deflation alter the terms of the loan?

How might a lender who anticipate deflation alter the terms of the loan?

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Answer #1

If the lender properly anticipates the deflation and thus falling net worth of the borrowers, a higher interest rate should be charged or additional collateral should be required. At the margin, low net worth borrowers will find financing.  

(Deflation is a fall in the overall price level. A borrower's liabilities will remain the same since loan repayment is usually specified in the nominal terms. But, the value of the borrower's assets will decline, decreasing the net worth of borrower.)

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