Interest Rates

Question 15 • 26-27 Ignite Technical Math-Financial Math - MA2007

What effect does inflation have on interest rates, and why?

Answer

Inflation decreases interest rates, because it causes the principal amount to rise.

Inflation decreases interest rates, because borrowers in an inflationary economy cannot afford higher interest rates.

Inflation increases interest rates, because the money being lent out is more valuable after inflation.

Inflation increases interest rates, because lenders must charge more to gain a benefit on devalued money.

Explanation

Inflation reduces the purchasing power of money over time, so the money a lender is repaid is worth less in real terms. Lenders may charge higher interest rates to compensate for that loss and earn a return. Therefore, choice D is correct: lenders charge more to gain a benefit on devalued money.

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