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Suppose that a borrower and a lender agree on the nominal interest rate to be paid on a loan. Then inflation turns out to be higher than they both expected. a. Is the real Interest rate on this loan higher or lower than expected? b. Does the lender gain or lose from this unexpectedly high inflation? Does the borrower gain or lose? c. Inflation during the 1970s was much higher than most people had expected when the decade began. How did this affect homeowners who obtained fixed-rate mortgages during the 1960s? How did it affect the banks that lent the money? To find additional study resources, visit cengagebrain.com, and search for “Mankiw.”

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Principles of Macroeconomics (Mind...

8th Edition
N. Gregory Mankiw
Publisher: Cengage Learning
ISBN: 9781305971509

Solutions

Chapter
Section
BuyFindarrow_forward

Principles of Macroeconomics (Mind...

8th Edition
N. Gregory Mankiw
Publisher: Cengage Learning
ISBN: 9781305971509
Chapter 11, Problem 9PA
Textbook Problem
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Suppose that a borrower and a lender agree on the nominal interest rate to be paid on a loan. Then inflation turns out to be higher than they both expected.

a. Is the real Interest rate on this loan higher or lower than expected?

b. Does the lender gain or lose from this unexpectedly high inflation? Does the borrower gain or lose?

c. Inflation during the 1970s was much higher than most people had expected when the decade began. How did this affect homeowners who obtained fixed-rate mortgages during the 1960s? How did it affect the banks that lent the money?

 To find additional study resources, visit cengagebrain.com, and search for “Mankiw.”

Subpart (a):

To determine
Nominal interest rate, real interest rate and inflation.

Explanation of Solution

When inflation is higher than it was expected, the real interest rate on this loan will be lower than the expected. For instance, if the market equilibrium has an expected real interest rate of 4%...

Subpart (b):

To determine
Nominal interest rate, real interest rate and inflation.

Subpart (c):

To determine
Nominal interest rate, real interest rate and inflation.

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