Question

Considering its costs and causes, who do you think are inflation's biggest victims? Who does inflation hit the hardest? The poorer households or the richer households? Why? explain in 200 words.

Answer 1

Unexpected inflation arbitrarily redistributes wealth from one group to another group, such as from borrowers to lenders. When people decide to borrow money or lend money, they often consider what they think the rate of inflation will be. When the rate of inflation is different than anticipated, the amount of interest repaid or earned will also be different than what they expected.

• Lenders are hurt by unanticipated inflation because the money they get paid back has less purchasing power than the money they loaned out.

• Borrowers benefit from unanticipated inflation because the money they pay back is worth less than the money they borrowed.

Unanticipated disinflation or deflation, when the inflation rate is lower than it was expected to be (or even negative), has the opposite effect as unanticipated inflation: lenders are helped and borrowers are hurt.

Lenders are helped by unanticipated disinflation or deflation because the money they get paid back has more purchasing power than the money they expected it to be when they loaned it out.

Borrowers are hurt by deflation in particular because they have to pay back their debts with money worth more than the money they borrowed in the first place!

Most policies that target inflation are aimed at maintaining small and predictable rates of inflation. Inflation that is too close to zero runs the risk of becoming negative, and deflation becomes a possibility. Deflation has a very damaging impact on an economy and is associated with particularly severe recessions and depressions. If you hear about policymakers talking about "lowering inflation," their objective is slowing down the rate of inflation (in other words, disinflation), not deflation.

Inflation benefits debtors because the real value of what the owe diminishes. It hurts creditors because the repaid money is worth less than when they lent it out.

Unionized workers can collectively bargain for wage increases to counter the effects of inflation on their real wages.

Pensioners live on fixed income, with little power to counteract the effects of inflation other than to enter into riskier investments that provide higher returns.

It’s not inflation that has much effect, it’s unexpected inflation. And each of your three groups has fixed rate and floating rate versions.

A pensioner with an inflation-indexed pension cares little about inflation one way or the other. A pensioner with a fixed pension benefits if inflation is lower than what was expected at the time the pension amount was fixed, and loses if inflation is higher than expected.

Debtors with floating rate or short-term debt care little about inflation. Debtors with long-term fixed rate debt benefit if inflation is higher than expected at the time the debt interest rate was fixed, and lose if inflation is lower.

Unionized workers normally expect to be able to recapture inflation in wage negotiations. If they can, they don’t care too much about inflation. But if they lack full bargaining power, perhaps because their industry is shrinking or they are not well-organized or laws are not union-friendly, then they can benefit from lower than expected inflation, but higher than expected inflation allows employers to cut real wages.