Impact of expected inflation upon nominal interest rate and loanable funds:
Expected inflation and expected real interest rate are inversely related, given the nominal interest rate. In simple words, real interest rate would fall in future when expected inflation is high with given level of nominal interest rate.Expected fall in future real interest rate due to higher expected inflation will cause supplier to lend less and demanders to demand more, at each level of nominal interest rate, and thereby, demand will increase and supply will fall. Thus, nominal interest rate will increase. However, change in quantity of loanable funds depends on the expectation formulation of both suppliers and demanders.
For example, if expectation formulation toward inflation is same for both the suppliers and demanders, then the quantity of loanable funds will not change, which is shown in the below figure.Impact of expected inflation:
In Figure-1, initial equilibrium was at point "A" with 5 percent nominal interest rate and inflation, respectively, which means that the real interest rate was zero. Now, the expected inflation increases by 5 percent, that is, it increases from 5 to 10 percent and is same for both suppliers and demanders. Now, same expectation formulation will lead to an increase in demand for loan (rightward shift) and fall in supply of loanable funds (leftward shift). The new equilibrium will be at point "B". Hence, nominal interest will increase exactly by 5 percent and quantity of loanable fund remains unchanged.
Actual inflation and anticipated inflation
Actual inflation is the sum of anticipated inflation and unanticipated inflation. Anticipated inflation is expected while unanticipated inflation is unexpected or random in nature.When actual inflation is equal to the anticipated inflation, the unanticipated inflation is zero; when actual inflation is less than the anticipated inflation, the unanticipated inflation is negative. Similarly, when actual inflation is greater than the anticipated inflation, the unanticipated inflation is positive.If actual inflation is greater than the anticipated inflation, then the sellers of goods and services who had agreement to sale at price prior to inflation will lose their purchasing power and the buyers who agreed to purchase at that price will gain purchasing power.
Similarly, the lenders those who agreed to lend at nominal interest rate prior to inflation will lose their purchasing power and borrowers those who borrowed at that nominal interest rate will gain purchasing power.
Inflation can be defined as an instance, over the course of a year, during which the price level increases. Deflation is just the opposite; the price level decreases. Disinflation refers to a state of decreasing inflation levels. Hyperinflation, though with no specific threshold, is a particularly high level of inflation.
To calculate the inflation rate using the CPI, simply subtract the previous year's CPI from the current year to calculate the rate of inflation. An example is shown below, where I is equal to inflation.
Over the next 15 years, in order, the inflation (or deflation) rates were as follows:
3.7, 4.2, 4.5, 3.6, 2.5, 3.6, 5.6, 4.9, 2.8, 4.1, 4.9, 6.4, 6.3, 8.0, and -0.8.
The only time deflation occurred was from 2008 to 2009; the inflation rate was -0.8. Disinflation occurred between 1996-1998, 2000-2002, and 2005-2006. Since hyperinflation is hard to define, it should be taken as extremely high instances of inflation relative to other levels. Thus, in these calculations for example, it should be considered hyperinflation when the rate reaches 6% or more. This occurred in years 2004-2008.
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