Question

Consider the following four situations. In which situation would a borrower be best off and in which situation would a lender be best off? Explain

a. The nominal interest rate is 13 percent and the inflation rate is 10 percent.

b. The nominal interest rate is 5 percent and the inflation rate is 8 percent

c. The nominal interest rate is 6 percent and the inflation rate is –4 percent.

d. The real interest rate is 5 percent and the inflation rate is 2 percent.

Answer 1

The best situation for a borrower is when the real interest rate is negative, meaning that the inflation rate is higher than the nominal interest rate. On the other hand, the best situation for a lender is when the real interest rate is positive, meaning that the inflation rate is lower than the nominal interest rate.

Step-by-step explanation:

The best situation for a borrower is when the real interest rate is negative, meaning that the inflation rate is higher than the nominal interest rate. In situation c, where the nominal interest rate is 6% and the inflation rate is -4%, the borrower would be best off.

On the other hand, the best situation for a lender is when the real interest rate is positive, meaning that the inflation rate is lower than the nominal interest rate. In situation a, where the nominal interest rate is 13% and the inflation rate is 10%, the lender would be best off.