posted by Anonymous .
Assignment Question I can't find an answer too:
Assume that a series of inflation rates is 1 percent, 2 percent, and 4 percent, while nominal interest rates in the same three periods are 5 percent, 5 percent, and 6 percent, respectively.
a.What are the ex post real interest rates in the same three periods?
b.If the expected inflation rate in each period is the realized inflation rate in the previous period, what are the ex ante real interest rates in periods two and three?
c.If someone makes a loan in period two based on the ex ante inflation expectation in part b, will he or she be pleasantly or unpleasantly surprised?
a) real interest rate is nonminal rate less inflation.
b) ex ante means "before the facts" or "beforehand". So expected inflation in period 2 is inflation in period 1 = 1%.
c) the expected real interest in period 2 is interest less expected inflation = 5% - 1% = 4%. So, in period 2, the loaner got a 4% return rather than the ex post real rate of 3%. In year 3, the loaner gets a rate of 6% - 2% = 4% instead of the ex post real rate of 2%, I would say a pleasant surprise for the loaner in both years, (an unpleasant suprise for the loanee.)