supposes that a borrower and a lender agree on the nominal interest rate to be paid on a loan. Then inflation turns out to be higher than they both expectedInflation during the 1970s was much higher than most people had expected when the decade began.How did this affect homeowners who obtained fixed-rate mortgages during the 1960s?

How did it affect the banks who lent the money?

The higher-than-expected inflation during the 1970s had different effects on homeowners who obtained fixed-rate mortgages during the 1960s and the banks who lent the money. Let's break it down:

1. Impact on Homeowners:
Homeowners who obtained fixed-rate mortgages during the 1960s benefited from the higher inflation. This is because fixed-rate mortgages have a predetermined interest rate that remains constant throughout the loan term. As inflation goes up, the real value of the debt decreases since borrowers are repaying the loan with future dollars, which are worth less due to inflation. Therefore, homeowners with fixed-rate mortgages were able to pay off their mortgages with less valuable dollars, effectively reducing the real burden of the debt.

2. Impact on Banks:
On the other hand, the higher-than-expected inflation posed challenges for the banks that lent the money. Banks make loans with a fixed interest rate, which is determined based on the expected inflation rate. If actual inflation ends up exceeding the expected rate, the banks lose out on the potential interest they could have charged. This means that the real value of the interest payments they receive decreases because they are receiving future dollars that are worth less due to inflation. Consequently, the banks face reduced profits and lower-than-expected returns on their loans.

Overall, the higher-than-expected inflation during the 1970s benefited homeowners who obtained fixed-rate mortgages since they repaid their debt with less valuable dollars. However, it negatively impacted the banks that lent the money because they received lower real returns on their loans.