When the public expects inflation, real and nominal rates of interest will be the same.

Question

Quizplus · Accepted Answer

When the public expects inflation, nominal interest rates will be higher than real interest rates. This is because nominal interest rates include the inflation premium, which compensates lenders for the expected decline in the purchasing power of the money they lend. Real interest rates, on the other hand, reflect the true opportunity cost of borrowing money, which is the forgone return on alternative investments. Therefore, in an inflationary environment, real interest rates will be lower than nominal interest rates, as the inflation premium inflates the nominal rate.

When the Public Expects Inflation, Real and Nominal Rates of Interest