Question

Suppose that in 2019 there is a sudden unanticipated burst of inflation LOADING.... Consider the situations faced by the following individuals and determine who gains and who loses due to this inflation.

a. A homeowner whose wages keep pace with inflation in 2019 and makes fixed monthly mortgage payments to a savings bank. As a result of​ this, the homeowner gains and the savings bank loses .

b. An apartment landlord who has guaranteed to his tenants that their monthly rent payments during 2019 will be the same as they were during 2018 loses . The tenants who make fixed monthly rent payments gains .

c. A banker who made a fixed rate auto loan loses ​, but the auto buyer who will repay the loan at a fixed rate of interest during 2019 gains .

d. A retired individual who earns a pension with fixed monthly payments from her past employer during 2019 loses ​, but the employer who pays the fixed monthly payment to her gains .

Answer 1

Sustained increase in the general price level of goods and services in an economy over a period of time is referred to as inflation. Inflation may be caused by either of the two important reasons, such as,

• demand pull: When increased demand causes the rise in prices, then, it is said to be demand pull inflation. (or)
• cost push: When supply cost of goods and services increases results in rise in prices, it is said to be cost push inflation.

a. A home owner whose wages keep pace with inflation in 2019 and makes fixed monthly mortgage payments to a savings bank. In the given situation, the home owner gains because with inflation, the value for money decreases as a result he only needs to pay lesser amount in real terms, whereas the savings bank loses as it has charged on a fixed monthly payments, the bank cannot charge more by adjusting inflation.

b. An apartment landlord who has guaranteed to his tenants that their monthly rent payments during 2019 will be the same as they were during 2018. Same as in situation (a), the apartment landlord would lose because of decreasing value of money during inflation. The tenants would gain because they pay a fixed monthly rent, as they need to pay only less money in real terms and the landlord has already assured the tenants the rent will be the same as 2018. Hence, landlord cannot increase the amount and thus tenants benefits from inflation.

c. A banker who made a fixed rate auto loan definitely loses, but the auto buyer gains because the payment is made on a fixed rate which is already decided and hence cannot be adjusted to inflation.

d. A retired individual who earns a pension with fixed monthly payments from her past employer during 2019 loses, but the employer who pays the pension gains. As the pension is paid as a fixed monthly payments, the retired individual is worse off from inflation whereas the employer is benefited from the same, because the amount need to be paid is of less value in real terms, due to inflation.

From all the above mentioned situations, it is understood that inflation decrease the value of money. Also, the creditor, especially with fixed rate repayments are worse off while the borrower or tenants, who pays at fixed rate is benefited.