Question

Name _____________________________________________________

Part 1: Practice​- ​Choose the most likely category for each of the following situations.

H = harmed by unanticipated inflation, B = benefits from unanticipated inflation, U = uncertain

1. _____ Hurley, a farmer, buys machinery with a fixed-rate loan to be repaid over seven years
2. _____ A bank lends money at a fixed interest rate
3. _____ Jacob buys a new home with an adjustable-rate mortgage
4. _____ Ben’s savings from his part-time job are in a savings account paying a fixed rate of interest.
5. _____ Sawyer’s retirement income is earned from assets that pay a fixed rate of interest
6. _____ Jack signs a rental agreement to pay $1500 a month for an apartment for three years
7. _____ Kate, a retired bank robber, has put all her retirement money into stocks
8. _____ The federal government has a $21 trillion debt
9. _____ A firm signs a contract to provide website consulting services at a fixed price for four years
10. _____ 90% of a state’s tax revenue is from income tax
11. _____ Claire agrees to pay her parents back the price of college tuition after she graduates
12. _____ Bank of America loaned $10 billion in fixed-rate loans for home mortgages

_____ Desmond puts money in his son’s savings account paying .25% interest

Answer 1

1) B

Hurley benefits from unanticipated inflation because real interest rate paid falls with inflation.

2) H

Bank is harmed by unanticipated inflation because the real interest rate received will fall with inflation.

3) U

Jacob's situation is uncertain because it depends on how much the interest rate adjusts with inflation.

4) H

Ben is hurt as inflation reduces purchasing power of fixed income securities.

5) H

Sawyer is hurt as inflation reduces the purchasing power of fixed income securities.

6) B

Jack benefits as real value of his fixed rent paid falls with inflation.

7) U

Stock prices may move in any direction so Kate may lose or gain. (However, stocks are better hedge against inflation than bonds).

8) B

Borrowers gain after inflation because now, the money repaid by them has lower real value due to inflation.

9) H

Firm's fixed fee will decrease in real terms with inflation.

10) U

Nominal wage increases during inflation so nominal income tax would also increase. However, the real value of tax revenue may fall if inflation is too much.

11) B

Claire benefits as the amount she repays has less value due to inflation.

12) H

Bank of America is hurt as real value of fixed rate received will fall with inflation.

13) H​​​​​​

Desmond is hurt as fixed income securities are negatively affected by inflation.