If borrowers and lenders agree on a nominal interest rate and inflation turns out to be less than they had expected,

Question

a. borrowers will gain at the expense of lenders.
b. lenders will gain at the expense of borrowers.
c. neither borrowers nor lenders will gain because the nominal interest rate has been fixed by contract.
d. none of the above is true.

Answer 1

If borrowers and lenders agree on a nominal interest rate and inflation turns out to be less than they had expected, it means that the real interest rate (nominal interest rate minus inflation) ends up being higher than anticipated. In this situation:

• Borrowers will have to pay back their loans with money that has more purchasing power than they anticipated, which is disadvantageous to them.
• Lenders will benefit because they receive repayments that have greater purchasing power than they initially expected.

Therefore, the correct answer is:

b. lenders will gain at the expense of borrowers.