Question

When the expected inflation rate increases, the real cost of borrowing ________ and bond supply ________, everything else held constant.

a) increases; increases
b) increases; decreases
c) decreases; increases
d) decreases; decreases

Answer 1

Answer:

The answer is: C) decreases ; increases

Explanation:

The real cost of borrowing is calculated by adjusting the nominal cost of borrowing by the inflation rate. This means that if the inflation rate increases, then the adjusted real cost of borrowing will decrease.

The inflation rate increases when country´s money supply growth rate outpaces its economic growth. So when the inflation rate increases (lowering the real cost of borrowing), borrowers are more likely to issue bonds, increasing the bond supply.