Question

When the actual inflation rate turns out to be greater than the expected inflation rate, who gains—the borrower or the lender—and who loses? Explain why.

Answer 1

When the actual inflation rate turns out to be greater than the expected inflation rate then the borrower gains and the lender loses.The borrower gains because the borrower has to pay back the loan in a much cheaper dollars(currency) since the value of currency's purchasing power reduces due to inflation. What I mean by purchasing power is that how much goods or items your money can buy also called buying power. Since inflation means rise in price of goods, as inflation rises the purchasing power decreases even more thus decreasing the interest rate. Here the purchasing power has reduced more than expected so interest rate has reduced more so the borrower pays less interest to the lender. The lender loses because he received currency that has lost its purchasing power more than expected. The lender will get less interest from the borrower.