You borrow $\$ 200$ from the First Bank of Westeros to purchase Kraken repellant. The bank charges a fixed nominal interest rate of $18 \%$ per year and you will repay them in one year. You and the bank both anticipate that there will be $7 \%$ inflation. However, after the loan agreement is signed, the rate of inflation turns out to be $9 \%$.

Who is hurt by this unanticipated inflation, and why are they hurt by it?
Choose 1 answer:
(A) The bank is hurt because the value of what is repaid has decreased
(B) You are hurt because the value of what is repaid has decreased
(C) The bank is hurt because the value of what is repaid has increased
(D) You are hurt because the value of what is repaid has increased
(E) We cannot tell without more information

Question

You borrow $\$ 200$ from the First Bank of Westeros to purchase Kraken repellant. The bank charges a fixed nominal interest rate of $18 \%$ per year and you will repay them in one year. You and the bank both anticipate that there will be $7 \%$ inflation. However, after the loan agreement is signed, the rate of inflation turns out to be $9 \%$.

Who is hurt by this unanticipated inflation, and why are they hurt by it?
Choose 1 answer:
(A) The bank is hurt because the value of what is repaid has decreased
(B) You are hurt because the value of what is repaid has decreased
(C) The bank is hurt because the value of what is repaid has increased
(D) You are hurt because the value of what is repaid has increased
(E) We cannot tell without more information

Accepted Answer

***A*** ∻Key Concept∻ ⚹Real Interest Rate and Inflation⚹ ∻Explanation∻ ⚹The bank is hurt by unanticipated inflation because the real value of the money repaid is less than expected. The real interest rate is the nominal rate adjusted for inflation. With higher inflation, the real interest rate is lower, benefiting the borrower at the expense of the lender.⚹◊How does unexpected inflation affect the real value of loan repayments in the context of macroeconomics?⍭ Generate me a similar question◊

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