Suppose there an unexpected increase in inflation. Then:Group of answer choicesBorrowers and lenders are worse off by the same amountThere is a redistribution from lenders to borrowersBorrowers and lenders are better off by the same amountThere is a redistribution from borrowers to lenders
Question
Suppose there an unexpected increase in inflation. Then:Group of answer choicesBorrowers and lenders are worse off by the same amountThere is a redistribution from lenders to borrowersBorrowers and lenders are better off by the same amountThere is a redistribution from borrowers to lenders
Solution
There is a redistribution from lenders to borrowers.
Here's why:
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Inflation is the rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling.
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When inflation increases unexpectedly, the value of money decreases. This means that the same amount of money will buy fewer goods and services than before.
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If you're a borrower, this is good news. The money you'll be paying back in the future will be worth less than the money you borrowed. In other words, the real value of your debt has decreased.
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On the other hand, if you're a lender, this is bad news. The money you'll be getting back in the future will be worth less than the money you lent. In other words, the real value of your asset (the loan) has decreased.
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Therefore, an unexpected increase in inflation leads to a redistribution from lenders to borrowers.
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