Question

Explain how unanticipated inflation leads to redistribution of income and wealth between borrowers and lenders. How is it harmful to economic growth? (2 points)

Answer 1

For Example, there are only two people in the economy one is the lender and one is the borrower. the lender has given a sum of $100 to the borrower in the year 2020. At this point the inflation in the market is 10% and interest rate is 15%.At this price the lender can buy a basket of apple. AS the interest rate is more than inflation by 5% the lender is expecting a return of 5% in its investment.

The inflation that was expected to remain at 10%, has increased to 17%. At this rate the lender will get a negative return of 2%, The basket of apple will be costing $117, where as the expected price of the basket was to be 110.

Inflation transfers the wealth form the lender to the borrower because the money which the borrower returns has less purchasing power. It is harmful for the economy because it decreases the purchasing power of the consumer in the market and reduces the demand