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

Money tends to devalue, i.e. you buy less goods for a certain amount of money in a year. Therefore, the loan at the nominal rate in a year will actually be less in amount. Therefore, it is not profitable.The real profit is the profit adjusted for inflation, so it has more purchasing power. Therefore, the real profit is better.