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IAI Actuarial Core Principles · Business Economics · Business activity, unemployment and inflation

Which of the following is generally regarded as a cost of unexpected inflation for an economy?

Unexpected inflation arbitrarily redistributes wealth from lenders and savers to borrowers, because fixed nominal repayments are worth less in real terms than anticipated. This uncertainty is a recognised cost of inflation, along with menu costs and distorted price signals.

  1. AIt makes all nominal debts easier for lenders to recover in real terms
  2. BIt redistributes wealth arbitrarily from lenders to borrowers when loans are at fixed nominal ratesCorrect
  3. CIt increases the real value of fixed-rate savings
  4. DIt removes the need for firms to change their price lists
  5. It guarantees faster real economic growth

Explanation

If inflation is higher than expected, the real value of fixed nominal repayments falls, so borrowers gain and lenders lose, an arbitrary redistribution. Savers with fixed-rate deposits lose, not gain. Inflation also raises menu costs, and no guarantee of growth exists.

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