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Chapter 9: Q.9 (page 242)

How should an increase in inflation affect the interest rate on an adjustable-rate mortgage?

Short Answer

Expert verified

An increase in inflation affects the interest rate on an adjustable-rate mortgage by reducing the interest rate.

Step by step solution

01

Step 1. Meaning

The inflation rate is an increase in the price of goods and services over time that decreases the purchasing power of money.

An adjustable-rate mortgage which is also called a variable-rate mortgage and tracker mortgage, is a mortgage when the interest rate of a loan is adjusted based on the index that shows the lender's cost of borrowing on the credit market.

02

Step 2. Explanation

Adjustable-rate mortgages as the name suggests can be adjusted, the more the inflation, the higher the interest rate on the adjustable-rate mortgage, so more inflation reduces the real interest rates on a fixed-rate mortgage.

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Most popular questions from this chapter

The Consumer Price Index is subject to the substitution bias and the quality/new goods bias. Are the Producer Price Index and the GDP Deflator also subject to these biases? Why or why not?

A fixed-rate mortgage has the same interest rate over the life of the loan, whether the mortgage is for 15 or 30 years. By contrast, an adjustable-rate mortgage changes with market interest rates over the life of the mortgage. If inflation falls unexpectedly by 3%, what would likely happen to a homeowner with an adjustable-rate mortgage?

22. Inflation rates, like most statistics, are imperfect

measures. Can you identify some ways that the inflation rate for fruit does not perfectly capture the rising price of fruit?

Describe a situation, either a government policy situation, an economic problem, or a private sector situation, where using the CPI to convert from nominal to real would be more appropriate than using the GDP deflator.

What is indexing?
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