University level economics?

Question

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 a fixed rated mortgages during the 1960s? How did it affect the banks that lent the money?

Answer 1

a. Lower
b. Lender loses, borrower gains.
c. Homeowners gained, banks lost.

Answer 2

A lower
B Yes; Gain
C They had lower interest rates than the going rate; they could get more money from the loans they were currently giving.

If you where a bank and you had 100,000 dollars and the going rate for that loan was 7% (3% margin, or profit, and 4% cost to get the money it bank accounts and Cd's) and you loaned the money. Assume inflation occurred heavily. Now the interest rate you could get on that same 100,000 is 20%. How would you feel? Would you want that money back so you could lend it to someone else? YES you would. that is what happened. Would the borrower want to refinance and give the money back? NO.

Answer 3

well the lender for sure doesn't make as much as he wanted to, and homeowners who got fixed rate mortgages got a sweeter deal than they expected, unless the lender saw the inflation coming (doubtful)

Answer 4

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