With no inﬂation, a bank would be willing to lend a business ﬁrm $5 million at an annual interest rate of 6 percent. But if the rate of inﬂation was anticipated to be 4 percent, the bank would most likely
Charge the ﬁrm an annual interest rate of
A) 2 percent.
B) 4 percent.
C) 6 percent.
D) 10 percent.

Question

Quizplus · Accepted Answer

With an anticipated inflation rate of 4%, the bank would factor this into their lending and adjust their interest rate accordingly. The real interest rate that the bank wants to earn is 2%, based on the difference between their desired rate and the anticipated inflation rate. Therefore, the bank would add the 4% inflation rate to the 2% real interest rate for a total annual interest rate of 6%. This is the same rate as the scenario with no inflation, because the bank is still earning their desired real interest rate of 2% in both cases. Thus, the answer is D) 10 percent, which is the sum of the 6% nominal interest rate plus the 4% anticipated inflation rate.

With No Inﬂation, a Bank Would Be Willing to Lend