Reference no: EM132492503

1) Describe the overall movements of short and long term real interest rates over the past 30 years. Are real interest rates roughly constant over time?

2) Why do investors dislike inflation?

3) In each of the following situations, explain whether borrowers or lenders are worse off, better off, or equally well off because of unexpected inflation.

A. Expected inflation one year ago was 4 percent; actual inflation over the year turned out to be 7 percent.

B. Expected inflation one year ago was 5 percent; actual inflation over the year turned out to be 3 percent.

C. The nominal interest rate on a loan was 8 percent; the expected real interest rate on the loan was 4 percent; actual inflation over the year turned out to be 3 percent.

D. The nominal interest rate on a loan was 8 percent; the expected real interest rate on the loan was 5 percent; actual inflation over the year turned out to be 3 percent.

4) Suppose that the Fisher hypothesis holds for an economy that has an expected real interest rate of 2 percent. For each of the expected inflation rates of 0, 2, 4, 6, and 8 percent, calculate the nominal interest rate and the after-tax expected real interest rate if the tax rate is 30 percent.

5) When inflation is unexpectedly high, the stock prices of banks usually decline sharply. Can you explain why?

6) Why would anyone lend money if there were a negative after-tax expected real interest rate?