Answer to Question #224404 in Macroeconomics for Zainab

Question

Suppose you make a loan of $100 that will be repaid to you in 1 year. If the loan is denominated in terms of a nominal interest rate, are you happy or sad if inflation is higher than expected during the year? What if the loan instead had been denominated in terms of a real return?

Answer 1

If the inflation will be higher the expected and the loan is denominated in teams of the normal rate which is the sum of real interest plus the inflation rate then I will be disappointed to repay more than what I expect to pay since the increase in the inflation rate will cause an increase in the nominal rate. However, if the loan is dominated in terms of real returns, I will be advantaged because real returns are always lower than nominal returns which do not subtract taxes, and inflations.