ECO102H1 Lecture 40: Lecture 40-Inflation

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copperclam445

1 Aug 2010

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Professor

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March 25th 2010

Inflation

Interest Rates and Inflation

Borrowers and lenders: concern is with Real interest rate Ù change in purchasing power

Nominal interest rate = Real Interest Rate + Expected inflation

Real Interest Rate = Nominal Interest Rate ± Expected Inflation

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1. Firm wishes to borrow for one year to build plant. Interest Rate is 10%.

2. Is this interest rate High or Low?

Answer: Depends on inflation rate.

Example:

Inflation 10% Æ

(i) cost of building plant (materials, labour) will be 10% higher next

year

(ii) goods to be produced @ plant will sell @ 10% higher prices next

year

Ö interest rate is low

Year

1981

2006

(nominal) interest rate,

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16%

4.25%

Expected inflation

13%

2.00%

Real interest Rate

2.25%

Does inflation hurt savers?

Answer: only if unanticipated

Redistributive Effects (again)

Real Interest Rate 4%

Expected Inflation Rate 5%

Nominal Interest Rate 9%

#1 Actual Inflation (8%) > Expected Inflation (5%)

Real Interest Rate = 9% - 8% = 1% (not 4%)

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Related Questions

A8. Consider the situations of a lender of money and a borrower of money. Which of the following situations is least burdensome for the borrower? (A) (B) (C) (D) (E) Nominal interest rate of 4% and an inflation rate of 4%. Nominal interest rate of 15% and an inflation rate of 8%. Nominal interest rate of 8% and an inflation rate of 2%. Nominal interest rate of 10% and an inflation rate of 1%. Nominal interest rate of 29% and an inflation rate of 21%.

Which of the following statements is TRUE?

	If the nominal interest rate is 5% and the inflation rate is 2.5%, the real interest rate is 2.5%.
	If the nominal interest rate is 5% and the inflation rate is 4%, the real interest rate is 9%.
	If the real interest rate is 3% and the inflation interest rate is 5%, the nominal interest rate is 2%.
	If the real interest rate is 3% and the nominal interest rate is 5%, the inflation rate is 8%.

taupeeel656

Suppose the real interest rate is 2% and the nominal interest rate is 5%. What is the expected inflation rate?

ECO102H1 Lecture 40: Lecture 40-Inflation

ECO102H1 Full Course Notes

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