ECON: MACRO4
4th Edition
ISBN: 9781305436862
Author: William A. McEachern
Publisher: Cengage Learning
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Question
Chapter 7, Problem 3.9PA
To determine
- The effect of an increase in the expected inflation in the equilibrium in the loanable funds market.
Concepts introduced Expected Inflation - This refers to the anticipated increase in the level of prices over a given period of time resulting from the subjective views about price trends in future. In other words, prices today are affected by what they may be tomorrow culminating into expected inflation.
Fisher Effect
In the late 1930s, U.S. economist Irving Fisher established an economic hypothesis
is implies that the nominal or the current interest rate is the real interest rate adjusted for the rate of inflation.
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Initially, Megan earns a salary of $300 per year and Larry earns a salary of $200 per year. Megan lends Larry $100 for one year at an annual interest rate of 16% with the expectation that the rate of inflation will be 12% during the one-year life of the loan. At the end of the year, Larry makes good on the loan by paying Megan $116. Consider how the loan repayment affects Megan and Larry under the following scenarios.
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3. Inflation and the nominal interest rate
When the actual and expected (or anticipated) inflation rates are both zero, the nominal interest rate must equal the real interest rate. How might
inflation affect the nominal interest rate? The nominal interest rate is determined by the forces of supply and demand in the loanable funds market (in
millions of dollars).
The following graph input tool shows the market for loanable funds. Use the graph input tool to help you answer the questions that follow. You can
shift the supply and demand curves by changing the values of the supply and demand shifters on the right. You will not be graded on any changes you
make to the graph input tool.
INTEREST RATE (Percent)
0
0
100
200
400
300
LOANABLE FUNDS (Millions of dollars)
500
Graph Input Tool
Interest Rate
(Percent)
Quantity demanded.
(Millions of dollars)
Demand Shifter
Expected Inflation
(percent)
When the expected inflation rate is zero, the nominal interest rate is
rate of
and a real interest…
Inflation and interest rates
a) Define/explain the consumer price index. b)
Suppose that the nominal interest rate is 6.5%
per year and you borrow $200. How much
money will you have to repay in a year? c)
Suppose that the nominal interest rate is
again 6.5% and inflation is 1%. What is the real
interest rate? d) Now suppose that the
nominal interest rate is 1% and the inflation
rate is 1.5%. What is the real interest rate?
Would you like to be a lender or a borrower in
this case? Why?
Please explain/show how to do the
calculations
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