The nominal interest rate is defined as the amount paid the borrower to the lender for using the borrowed amount for a specific period. Real interest rate calculated based on actual value (inflation-adjusted), is approximately equal to the difference between the nominal rate and expected rate of inflation in the economy. Which of the following assertions is best supported by the above information?

Option 1 : Under high inflation, the real interest rate is low and borrowers get benefited

Concept:

• Real interest rate:

It is the rate of interest on which a borrower pays the amount to the lender. In this rate of interest rate inflation rate is also adjusted.

• The nominal rate of interest:

It is the rate of interest on which the borrower pays the amount to the lender. In this rate of the interest rate of inflation is not considered.

• The relation between the real rate of interest, the nominal rate of interest, and inflation rate:

The real rate of interest = Nominal rate of interest – rate of inflation

Explanation:

Statement 1: under the high inflation, the real rate of interest is low and borrowers get benefited.

• The real rate of interest = Nominal rate of interest – rate of inflation.
• As we can see, if the rate of inflation increases, the real rate of interest decreases, and the rate at which borrowers had to pay the lender before is also less, hence the borrower gets benefited.
• Hence statement 1 is correct.

Statement 2: under the low inflation, the real rate of interest is high and borrowers get benefited.

• The real rate of interest = Nominal rate of interest – rate of inflation.
• As we can see, if the rate of inflation decreases, the real rate of interest increases, and the rate at which borrowers had to pay the lender before is high, hence the lender gets benefited, borrowers are in loss.
• Hence statement 2 is wrong.

Statement 3: under the high inflation, the real rate of interest is low and lenders get benefited.

• The real rate of interest = Nominal rate of interest – rate of inflation
• As we can see, if the rate of inflation increases, the real rate of interest decreases, and the rate at which borrowers had to pay the lender before is less, hence the borrowers get benefited, lenders are in loss.
• Hence statement 3 is wrong.

Statement 4: Under the low inflation, the real rate of interest is low and borrowers get benefited

• The real rate of interest = Nominal rate of interest – rate of inflation
• As we can see, if the rate of inflation decreases, the real rate of interest increases, and the rate at which borrowers had to pay the lender before is high, hence the lenders get benefited, borrowers are in loss.
• Hence statement 4 is wrong.