Question

13. During the last tax year you lent money at a nominal rate of 6 percent. Actual inflation was 1.5 percent, but people had been expecting 1 percent. This difference between actual and expected inflation
A. transferred wealth from the borrower to you (lender) and caused your after-tax real interest rate to be 0.5 percentage points higher than what you had expected.
B. transferred wealth from the borrower to you (lender) and caused your after-tax real interest rate to be more than 0.5 percentage points higher than what you had expected.
C. transferred wealth from you (lender) to the borrower and caused your after-tax real interest rate to be equal to what you had expected.
D. transferred wealth from you (lender) to the borrower and caused your after-tax real interest rate to be more than 0.5 percentage points lower than what you had expected.
E. transferred wealth from you (lender) to the borrower and caused your after-tax real interest rate to be 0.5 percentage points lower than what you had expected.

14. Which of the following statements about unexpected inflation is (are) correct?
(x) High and unexpected inflation has a greater cost for those who save, than those who borrow.
(y) If inflation is more than expected, debtors (borrowers) pay a lower real interest rate to creditors (lenders) than they had anticipated.
(z) High and unexpected inflation has a greater cost for those who hold little money, than those who hold much money.
A. (x), (y) and (z)
B. (x) and (y) only
C. (x) and (z) only
D. (y) and (z) only
E. (x) only

15. which of the following statements about the U.S. is (are) correct?
(x) Between 1880 and 1896 unexpectedly low inflation transferred wealth from debtors to creditors
(y) In 1898, prospectors near the Klondike River in the Canadian Yukon discovered gold. This discovery caused an unexpected price level increase that helped debtors at the expense of creditors.
(z) An increase in the supplies of gold in the late 1890s caused an increase of money in the United States because the U.S. was tied to a gold standard.
A. (x), (y) and (z)
B. (x) and (y) only
C. (x) and (z) only
D. (y) and (z) only
E. (x) only

Answer 1

Q.13) Correct one: Option E.

Difference in inflation is 0.5%. The difference in actual after tax real interest rate and expected is minus 0.5%. Because expected real int rate = nominal roi - expected inflation. The lowered after tax real rate of interest makes the borrower better off by causing a wealth transfer from the lender to the borrower.

14) (x), (y), (z) only.

X and Y can be inferred from the explanation for the above question. Z is correct because high inflation erodes the real interest rate incomes. Wear and tear costs of taking money out of banks is higher for the one holding less cash.

15) C. X and Z only
X is correct because low inflation implies higher real rate of interest than expected causing wealth transfer from debtors to creditors.
Y is wrong because discovery of gold leads to excess supply of gold and thereby reducing the price of gold. $1 can buy more gold than before, so it should be deflation helping creditors.
(Z) is correct as the central bank can now print more currency to match with the increase in the gold supply. Thats the working of gold standard.