Suppose the nominal interest rate on car loans is 8% per year. If borrowers and

Question

Suppose the nominal interest rate on car loans is 8% per year. If borrowers and lenders expect an inflation rate of 5% per year, they will expect a real interest rate of per year. Suppose the Fed increases the growth rate of the money supply, causing the inflation rate to unexpectedly rise from 5% to 7% per year. The real interest rate on car loans will in inflation arbitrarily harms to per year. This unanticipated change Now consider the scenario in which people fully anticipate the increase in the inflation rate. When the increase in the inflation rate from 5% to 7%, the inflation premium will will people anticipate and the nominal interest rate to In-this case, borrowers will be by the anticipated inflation.

Explanation / Answer

1 8-5=3%

2 fall to 8-7=1%, lenders as they get lower real returns

3 will rise, 2%, will be harmed

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