Question

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Posted 2 months ago

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Tyrion has managed to save up $\$ 1,000$ which he has deposited in a Westeros Bank account that pays $4 \%$ interest.
Which of the following will be true if the actual inflation rate is lower than the expected inflation rate?
Choose 1 answer:
(A) We cannot tell without more information
(B) Tyrion and the bank would both benefit
(C) Neither benefit
(D) Both are worse off
(E) Tyrion would benefit; the bank would be worse off
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Answer from Sia

Posted 2 months ago

Solution by Steps

step 1

Calculate the real interest rate with the expected inflation rate: The real interest rate can be calculated using the formula $r = i - \pi_e$, where $r$ is the real interest rate, $i$ is the nominal interest rate, and $\pi_e$ is the expected inflation rate

step 2

Calculate the real interest rate with the actual inflation rate: If the actual inflation rate is lower than the expected inflation rate, the real interest rate will be higher than initially calculated. This can be represented as $r_{actual} = i - \pi_{actual}$, where $\pi_{actual} < \pi_e$

step 3

Analyze the impact on Tyrion and the bank: A higher real interest rate means that the purchasing power of the money Tyrion receives from the bank increases, benefiting Tyrion. Conversely, the bank receives money back that has a higher purchasing power than expected, which is a disadvantage for the bank

Answer

E

Key Concept

Real Interest Rate and Inflation

Explanation

When the actual inflation rate is lower than the expected inflation rate, the real interest rate is higher, benefiting the depositor (Tyrion) and disadvantaging the bank.

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