Which of the following situations will benefit lenders of fixed interest rate loans?

• A. Actual inflation is higher than expected inflation.
• B. Actual inflation is lower than expected inflation.
• C. Nominal interest rates decrease after the loan is issued.
• D. Borrowers' incomes rise faster than the inflation rate.

Answer: (B)

Verified step by step guidance

1. Understand the relationship between inflation and fixed interest rate loans: lenders agree to receive a fixed nominal interest rate, which does not change regardless of actual inflation.
2. Recall that the real interest rate is approximately the nominal interest rate minus the inflation rate, i.e., \(\text{Real Interest Rate} \approx \text{Nominal Interest Rate} - \text{Inflation Rate}\).
3. Analyze what happens if actual inflation is higher than expected inflation: the real interest rate received by lenders decreases, which harms lenders because the money repaid has less purchasing power.
4. Analyze what happens if actual inflation is lower than expected inflation: the real interest rate received by lenders increases, benefiting lenders because the money repaid has more purchasing power than anticipated.
5. Evaluate the other options: nominal interest rate decreases after the loan is issued (does not affect fixed rate loans), and borrowers' incomes rising faster than inflation (affects borrowers' ability to pay but not directly lenders' real returns).