Question

“Unexpected inflation is more beneficial to those who save than those who borrow.” Evaluate this statement. How does your answer change if the inflation is expected? Please elaborate

Answer 1

The statement is false. Unexpected inflation is more beneficial to borrowers and a disadvantage to savers.

Unexpected inflation means that the savers now get lower real return on their savings because real return would be nominal return minus inflation rate. Since inflation is unexpected, savers must not have taken it into account and the real rate of return that they expected is now actually lower. So savers lose. On the other hand, the borrowers benefit because the interest paid by them was fixed without taking into account the unexpected inflation and is thus lower than what would otherwise be if inflation was considered while determining interest rate. Moreover, if they repay the loan when unexpected inflation occurs, the real value of money paid back is lower. So borrowers gain.

Expected inflation does not have the above effect. It does not cause borrowers and savers to gain or lose. Since inflation is known in advance, the rate of return on savings as well as interest on loan takes this expected inflation into account. Thus, borrowers don't gain and savers don't suffer a disadvantage.