5. If you borrowed a car loan last year at 7% when inflation was expected to...

5. If you borrowed a car loan last year at 7% when inflation was expected to be 4% and now inflation is expected to be only 1%, then who is better off, you or the lender? Why?

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Expert Solution

The interest rate that you are charged is calculated as

Nominal interest rate real interest rate + inflation rate

Real interest rate remains constant across different economies otherwise there would be inflow of funds to the economy having a higher real interest rate.

If the inflation rate falls the nominal interest falls, thus effectively benefiting the lender since it has issued a loan at a higher interest rate than it would have received issuing a loan at the current interest rate.

The Lender will be able to receive higher expected interest payment on the loan than would receive right now.

I would be better off refinancing the loan at lower interest rate unless there is a prepayment penalty.

jeff jeffy answered 2 years ago

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