Suppose that you are running a business and you need some extra space for one year. Your bank tells you that you can borrow $100,000 at 0% interest to purchase a building. You consider borrowing this amount, buying the building, using it for one year, and then selling the building to pay back the loan. Unfortunately, the economy in which you are operating is experiencing deflation at the rate of 10% per year. After one year, you should be able to sell the building for about how much? $100,000 $110,000 $90,000 You calculate that if you had the building for the year, it would give you an extra $5,000 in income and wonder if you should go ahead and buy the building. Your brother tells you that if you use a $100,000 building for one year, it costs you $100,000, so you should not buy the building. Your accountant says that because there is no interest cost on the loan, you should definitely buy the building. You will have $5,000 in extra income and no additional interest cost. Your bookkeeper says that if you use the building for a year, you will have to come up with more money to pay off the loan than you will make in extra income. Who is right? Your bookkeeper is right because the extra income you will earn will be less than the cost of owning the building for the year. Your accountant is right because when the nominal interest rate is zero, you do not incur any cost when you take out a loan. Your brother is correct because when the nominal interest rate is zero, the cost of a building is its full purchase price. Now suppose that your rich uncle dies and leaves you $100,000 in cash that he had kept hidden in his mattress. You go to the bank and ask what interest rate they would pay you if you deposited the cash in the bank. They say that they are offering a nominal interest rate of -1%. To maximize the amount of cash that you have in one year, what should you do? You should buy the building because you can earn an additional $5,000 in income if you own the building for one year and then sell it. You should hold onto your $100,000 in cash. You should deposit the cash in the bank because the 10% rate of deflation makes the value of your dollar's fall even more rapidly than 1% per year. True or False: A high real interest rate will keep firms from borrowing to finance investment in capital, but it will not keep firms with cash from investing in capital. True False