Unexpected inflation hurts lenders since the money they are paid back has less purchasing power than the money they lent out. Unexpected inflation benefits borrowers since the money they repay is worth less than the money they borrowed.
Who is harmed by unexpected inflation?
Savers and creditors suffer from unanticipated inflation since the money they give out is repaid in cheaper currency over time. Borrowers and debtors benefit from unexpected inflation because they borrow money at a fixed rate and pay it back in cheaper dollars over time.
Who is the most affected by inflation?
Inflation, which is always a key economic indicator, is especially important to monitor right now because it threatens to undermine, if not completely erode, the Biden administration’s massive spending on behalf of poor and working-class Americansits “economic justice” agenda (“Inflation Jumps to 13-Year High,” Page One, June 11). For poorer people, the effects of inflation are not just larger, but disproportionately greater. Price rises (for products and services) are often countered by greater income for those with higher earnings. Furthermore, prices for essential necessities sometimes rise faster than prices for luxury things, a phenomena economists refer to as “price inflation.” “Inflation disparity.” Simply put, low-income families’ budgets will be strained as they face higher costs for the necessities they require (food, energy, transport, child care).
Too often, the economic well-being of the most economically vulnerable Americans is described in terms of the most recent Washington program or policy. Those who act in the name of the “If we want to properly comprehend what’s happening not just to the economy in general but specifically to the most vulnerable within it, we need to pay more attention to basic economic indicators like employment rates by demographic group, incomes, and, yes, inflation.
What happens if inflation occurs unexpectedly?
1. Income and wealth will be redistributed due to unanticipated inflation, or inflation that is not foreseen. The redistribution of wealth occurs when the prices of some assets rise faster than the price level, while the prices of others rise more slowly.
Who benefits from inflation?
- Inflation is defined as an increase in the price of goods and services that results in a decrease in the buying power of money.
- Depending on the conditions, inflation might benefit both borrowers and lenders.
- Prices can be directly affected by the money supply; prices may rise as the money supply rises, assuming no change in economic activity.
- Borrowers gain from inflation because they may repay lenders with money that is worth less than it was when they borrowed it.
- When prices rise as a result of inflation, demand for borrowing rises, resulting in higher interest rates, which benefit lenders.
Quizlet: What is the impact of unexpected inflation?
What are the consequences of unexpected inflation? Unprecedented inflation results in arbitrary income redistributions.
What impact does inflation have on families?
Inflation has had an impact on families all around the country. Housing expenses are rising, as are grocery bills and petrol prices, requiring individuals to adjust their routines, stretch their budgets, or go without. It’s been particularly difficult for parents.
Tamika Calhoun is a Jackson, Mississippi-based housing counselor. She is also a mother of five children, and she is joining us from Jackson right now.
SIMON: And please accept my apologies in advance for the fact that these are really personal queries about the family finances. What are the current grocery prices? – Is there anything you’ve gone without?
CALHOUN: On my most recent trip to the grocery store, I had to prioritize what we needed over what the kids wanted. When the kids come out of school, they’ll want snacks and other items.
CALHOUN: So we’re down to attempting to stretch the snacks or purchasing a large bag of chips rather than individual bags since they’re so expensive now. Because I have such a large family, I spend close to a hundred dollars on a single supper. And…
CALHOUN:…It didn’t seem like I was spending that much money on a single dinner before, but now – especially the meat bits – it does. We have a large family, therefore we have to get the larger meat packs.
CALHOUN: It certainly does. We don’t go anywhere any longer because petrol is scarce due to its current high price.
SIMON: Are you scared that if you don’t go to work because you’re sick or fatigued, your family will suffer even more?
CALHOUN: Definitely – either I work or we won’t have a place to live – because we don’t live someplace where we get a subsidy, like we did previously, when I knew that if I lost my job, we’d be safe in low-income housing. The rent would be reduced to a more affordable level. However, we no longer reside there. I feel like I’ve finally arrived to a point where we can move on and support ourselves without the help of the government. And now, with everything going on, I’m wondering if I chose the worst moment to do this. This was not something I expected to happen. And I realized I was mentally preparing for it. However, my savings have been reduced as a result of having to leave work due to COVID.
CALHOUN: No, since I earn far too much money, despite the fact that it is insufficient to cover all of my expenses. However, they’re…
CALHOUN:…The government’s criteria haven’t changed. Even though the price is lower, you still can’t make more than this…
SIMON: You barely make enough money to support yourself and your family. However, you earn too much money to be eligible for government aid.
CALHOUN: That’s right. We would most likely be struggling more more than we are now if it weren’t for the pandemic EBT. We’ve been stretching that a bit.
SIMON: This is a government program that provides food aid to families that would otherwise be delivered through schools.
CALHOUN: They gave, I believe, two deposits, and each youngster received their own card. So that’s what’s been really helping us out with our grocery shopping.
CALHOUN: I make an effort to be optimistic. But, if I’m being honest, I’m hoping I don’t get COVID again, or that none of my children have COVID again. It’s terrifying to think that I’ll have to send them to school and then they’ll get sick. Then there’s the fact that I don’t have child care, so I’d have to miss work to be with them. It’s possible that I’ll have to quarantine with them. And if that happens, I won’t be able to use any of my PTO time.
SIMON: Tamika, you have five children and would go to great lengths for them. However, in order to assist them, you must remain healthy and well-nourished. Do you ever get hungry?
CALHOUN: There have been instances when I’ve made sacrifices in order for them to eat. And I try not to tell them I did it…
CALHOUN:…because I know they’ll try to hand up their meals to me. But they’ve never gone hungry simply because I find a way to feed them.
SIMON: You’re right. You make self-sacrifices for your children. All I can say is that I wish you the best of luck in the world.
CALHOUN: I appreciate that. I’m optimistic because I believe things will improve. As an example, even though the world isn’t turning around, I’m working on attempting to – since, as I previously stated, wages remain constant while prices rise. If that means finding a higher-paying work or getting a degree in something that will allow me to acquire a higher-paying job, I’ll just do what I can and hope for the best.
What are the effects of unexpected inflation on particular people and the economy as a whole?
Assume you borrow $1000 with a 5-year repayment period and a 5% yearly interest rate. You’ll have to pay back the loan when it’s due.
Assume, however, that the price level doubles during this five-year period.
Because a dollar will only be worth half as much in real terms, the amount of things you will have to give up to repay this loan will be half as much as the required dollar payment indicates.
As a result, you’ll only have to pay back $638.14 in real terms, based on the value of products at the time the money was borrowed.
This is fantastic from your perspective.
You’ll have borrowed $1000 in real goods for five years and only paid back $640 in actual things.
Substituting the real amount borrowed and the real amount repaid into the calculation will give you the interest rate you will have actually paid (rather than the 5% you negotiated for).
$1000 = $638.14 (1 + r)5, where r =- 1 = -.085 or minus 8.5 percent.
Despite the fact that you agreed to pay a 5% interest rate to the person you borrowed from, she ended up paying you 8.5 percent a year in interest to borrow from her.
Unprecedented inflation has shifted wealth from your creditor to you.
You’ve agreed to pay $1276.28 over five years, but you’ll only pay $638.14 in real terms.
To put it another way, the $1276.28 you repay will only buy half as many things as was anticipated when the loan was taken out.
The present value of the difference is $638.14 (1 + r)5 = $500, discounted at the market interest rate of 5%. This figure is not surprising given that a doubling of the price level wipes out half of the loan’s value in current dollars.
Of fact, if you lend $1,000 to someone for five years and the price level unexpectedly doubles over the length of the loan, the person you lend to will earn $500 in current dollars at your expense.
Unexpected inflation redistributes wealth from those who have agreed to receive fixed nominal amounts in the future to those who have agreed to pay those fixed nominal amounts in the future.
Deflation that occurs unexpectedly has the opposite impact.
The individual who has borrowed a set nominal amount must repay with dollars that are worth more in terms of real goods than he or she contracted for, and the creditor is paid an amount that is bigger in real terms than expected, redistributing wealth from debtors to creditors.
The real interest rate actually realized on loans will differ from the interest rate at which the loan contract was established if there is an unanticipated movement in the price level.
In the case of one-year loans, this realized real interest rate is simple to calculate.
Assume you borrow $100 for a year at an agreed-upon interest rate of 6%, and the inflation rate turns out to be 3% rather than zero percent, as both you and the lender expected when you took out the loan.
At the end of the year, you pay the lender $106, but that $106 is only worth roughly $103 because $100 will only buy $3 less products at the end of the year.
As a result, the actual interest rate is only roughly $3/$100, or 3%.
The realized real interest rate is roughly equal to the contracted interest rate less the actual inflation rate.
In an economy, unanticipated inflation has significant wealth redistribution implications.
People who take out mortgages to buy properties at fixed interest rates end up paying more in real terms than they bargained for-wealth is redistributed from banks and other financial institutions (or, more accurately, the people who own them) to mortgage-holders.
Individuals who retire on fixed-dollar-amount pensions will see their pensions eroded in terms of the goods they buy as time passes-in this case, the redistribution is from pensioners to the owners of insurance companies and other financial institutions who have contracted to pay them fixed-dollar-amount pensions.
Inflation that is unexpected has additional distributional implications that are mediated by the tax system.
Many nations have progressive income tax systems, in which high-income individuals pay a larger percentage rate of tax on income increases than low-income individuals.
Because income tax rates are based on nominal rather than real income, rising nominal incomes will push people into higher tax brackets, increasing the amount of taxes paid to the government in a greater proportion than rising prices.
As a result, real tax payments and the government’s resource availability will rise.
Fully expected inflation has the same impacts unless the tax structure is changed to account for it.
Furthermore, in order to calculate the profits on which they must pay taxes to the government, business firms are typically allowed to subtract allowances for depreciation of their capital from their revenues.
Depreciation allowances are typically expressed as a percentage of the original cost.
These depreciation allowances based on the prices prevalent when the capital was purchased do not rise when inflation occurs and all nominal prices and salaries rise at the same time.
As a result, the real value of a firm’s cost deductions decreases, resulting in a rise in real taxes paid.
Because inflation does not cut the real costs of replacing depreciated capital and real taxes rise, a firm’s real profits fall.
Depending on the specific regulations that the tax legislation requires them to follow in computing their depreciation allowances, different industries will be affected differently.
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What impact does unexpected inflation have on savers?
Because prices are expected to rise in the future, inflation might erode the value of your investments over time. This is particularly obvious when dealing with money. If you keep $10,000 beneath your mattress, it may not be enough to buy as much in 20 years. While you haven’t actually lost money, inflation has eroded your purchasing power, resulting in a lower net worth.
You can earn interest by keeping your money in the bank, which helps to offset the effects of inflation. Banks often pay higher interest rates when inflation is strong. However, your savings may not grow quickly enough to compensate for the inflation loss.