Question

Explain how savers and creditors are hurt by inflation while flexible income receivers and debtors may benefit from it.

Answer 1

Solution: Savers and creditors are the supplier of funds while the receivers and debtors are the borrower of the fund. Now let us suppose that there is some rate of inflation in the economy.Suppose a person Mr A has lend $ 10000 to Mr B and the current price in the economy 10 and the interest rate is 10% p.a.Let us suppose that the prices are rising at a rate of 20 % .

After 2 years

Amount to be paid by MR B to MR A = 10000 + 10000*10/100 * 2 = 12000

Now since there is inflation in the economy ,prices of the goods and services have rose to 10+10 *20/100 * 2 =14.

MR A if ,had not lend $ 10000 he can purchase 10000/10 =1000 units of goods.

but after 2 years he can purchase =12000/14 = 857.14 units of the goods only if he lends the money and there is a inflation in the economy.

From this example it is clear that the purchasing power of the lender is reduced due to inflation and it is the lender who is worse off not the borrower.