Question

Jack recently took out a loan from Diane at an interest rate of 4 percent. Diane expected this year’s inflation rate to be 3 percent and the real interest rate to be 1 percent. The loan is due at the end of this year. Complete the table below by computing the real interest rate for each possible inflation rate. For each situation, determine whether the unexpected inflation level benefits Jack or Diane.

Instructions: Enter your answers as whole numbers.

Actual inflation rate (%)	Actual real interest rate (%)	Who benefits?
2		(Click to select)   Diane   Jack
4		(Click to select)   Diane   Jack
-1		(Click to select)   Jack   Diane
-3		(Click to select)   Jack   Diane

Answer 1

Solution:

calculations:

Nominal interest rate = 4%

Actual inflation rate (%)	Actual real interest rate (%)	Who benefits?
1	2 [i.e., 4 - 2]	Jack
2	0 [i.e., 4- 4]	Jack
-1	5 [i.e., 4 - (-1)]	Diane
-3	7 [i.e., 4 - (-3)]	Diane

Actual real interest rate = Nominal interest rate - Actual inflation rate

When Actual real interest rate is less than Nominal interest rate, the borrower benefits.

When Actual real interest rate is greater than Nominal interest rate, the lender benefits.