Answer to Question #205125 in Macroeconomics for Nabeeha Khalid

Question

how are borrowers and lenders affected when the nominal rate is 9%, the inflation premiums on loans is 3% and the actual rate of inflation is 4%

Answer 1

According to the Fisher's equation, the nominal interest rate is the sum of real interest rate and inflation.

$Nominal \space interest\space rate=real\space interest\space rate+inflation$

The nominal interest rate was 9%, the expected inflation was 3% and the actual inflation was 4%.

$Nominal \space interest\space rate=expected \space real\space interest\space rate+expected \space inflation$

$9\%=real\space interest\space rate+3\%$

$expected \space real\space interest\space rate=9\%-3$

$expected \space real\space interest\space rate=6\%$

$Nominal \space interest\space rate=actual\space real\space interest\space rate+actual \space inflation$

$9\%=actual\space real\space interest\space rate+4\%$

$actual\space real\space interest\space rate=9\%-4\%$

$actual\space real\space interest\space rate=5\%$

The lenders expected a real return of 6% but only got an actual return of only 5%. Thus, they would be at a loss as the actual return would be low. The lenders will be at a loss. 

However, this would benefit borrowers as they would have to pay less real interest rate than expected. This would reduce the actual cost of their borrowing. The borrowers would be at a profit.