During the last year you lent money at a nominal rate of 6 percent. Actual infla

Question

During the last year you lent money at a nominal rate of 6 percent. Actual inflation was 1 percent, but people had been expecting 1.5 percent . This difference between actual and expected inflation

A. transferred wealth from the borrower to you and caused your actual real interest rate to be more than 0.5 percentage points higher than what you had expected.
B. transferred wealth from you to the borrower and caused your actual real interest rate to be more than 0.5 percentage points lower than what you had expected.
C. transferred wealth from the borrower to you and caused your actual real interest rate to be 0.5 percentage points higher than what you had expected.
D. transferred wealth from you to the borrower and caused your actual real interest rate to be 0.5 percentage points lower than what you had expected.

Explanation / Answer

Let us assume u lent $100 at 6% nominal rate.

You receive interest amountof 6% on $100. i.e $6.

$6 is without considering inflation.

With inflation, the nominal interest rate declines, this is called real interest rate.

real interest rate= nominal - inflation

                         = 6- 1= 5%

ur income is, $5

but actually, the inflation is 1.5

so real rate= 6-1.5= 4.5%

So, ur income is $4.5.

This implies ur loosing $0.5, due to ur miscaliculation of the inflation rate.

so, ur real interest rate had declined, form 5% to 4.5% by 0.5%. this had caused a transfer of wealth from yourself to the borrower.


D. transferred wealth from you to the borrower and caused your actual real interest rate to be 0.5 percentage points lower than what you had expected.

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