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Complete “Review Questions” 1 – 5 and “Numerical Exercises” 11 - 14 on pages 130 & 131 at the end of Chapter 6. Submit your work for grading by uploading your completed assignment as an attachment.

 

1.

Explain the difference between the expected real interest rate and the realized real interest rate. Which is more relevant for decision making? Why? Which is more relevant for determining whether a borrower or lender is better off or worse off because of unexpectedly high or low inflation? Why?

2.

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

What is the Fisher hypothesis? Is there convincing evidence for or against it?

4.

Why do investors dislike inflation?

5.

During recessions, do expected real interest rates increase or decrease? Explain why. What are the major forces acting on expected real interest rates in recessions?

6.

 

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An alternative type of mortgage loan is called a price level adjusted mortgage (PLAM) which sets all mortgage payments and the principal amount of the mortgage in real rather than nominal terms. Thus, if the inflation rate was 10 percent in dollar terms and the principal value of the mortgage loan also would be increased by 10 percent in dollar terms. Who gains from this type of mortgage the homeowner or the bank or both? Explain. Who bears the inflation risk?

7.

 

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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.

Answer:-