How does unexpected inflation affect the distribution of income among individuals?

It can benefit debtors at the expense of creditors if the loans have fixed interest rates.

It generally increases the purchasing power of consumers, boosting overall consumption.

All individuals gain equally because everyone's income rises with the rate of inflation.

It decreases nominal wages, leading to higher unemployment rates among workers.

What kind of fiscal policy action would be least likely contribute effectively towards controlling hyperinflation without drastically reducing productive capacity within an economy?

Reduce transfer payments sharply while maintaining current tax levels.

INCREASE taxes substantially more than transfer payments are cut.

Decrease government expenditure on goods & services dramatically

Create policies designed specifically target reduction velocity money circulation.

What happens to borrowers when actual inflation is higher than expected?

Borrowers benefit because they repay loans with less valuable dollars

Borrowers lose because they must repay more valuable dollars

The creditworthiness of borrowers decreases immediately

Borrowers have increased difficulty securing new loans

Which group may benefit from unanticipated inflation if they own assets such as real estate or stocks?

Borrowers with fixed interest rates

What can be an indirect effect of import costs rising due to high domestic inflation?

Domestic producers may face less competition from foreign firms, potentially raising prices further.

Increased competition from cheaper foreign products could lead domestic producers to lower prices.

High domestic inflation typically leads directly to increased export volumes due to lower production costs at home.

Domestic consumers might benefit from deflationary pressures caused by higher import costs over time.

Which type of common during periods of high inflation?

Barter system become more prevalent

Real incomes increase substantially

People rely on fixed long-term investments

How might a country experiencing high inflation impact its trade with other countries if it has a flexible exchange rate system?

The country's exports could become cheaper, increasing demand for its goods abroad.

It can cause the country to adopt fixed exchange rates to stabilize prices.

High inflation may lead to an increase in imports as foreign goods become relatively less expensive.

The central bank will need to increase interest rates dramatically, discouraging international investment.

How might consumers behavior change during a period where mild but steady inflation is expected?

They might increase current consumption anticipating higher future prices

They may entirely stop consuming due to non-predictable market conditions

Consumers will universally demand wage increases to match inflation rates

They would significantly increase saving due to expectations of lower future prices

What could be an indirect consequence on Country Y's balance of payments if inflation leads to tighter monetary policy causing its currency to appreciate?

A reduction in tourism revenues as visitors find it more costly to travel there might occur affecting the services balance negatively.

An improvement in terms-of-trade due to cheaper import prices might lead to a stronger current account position.

More attractive investment opportunities at home may reduce outward portfolio investment, benefiting the financial account.

Lowered demand for imports due to high costs might result in improved trade balances thus strengthening the current account temporarily.

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2.5 Costs of Inflation

5 min read•december 19, 2022

Jeanne Stansak

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Jeanne Stansak

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There are a variety of costs associated with . is a surprise, meaning that consumers and producers were not given time to adjust in advance. Remember that is a general rise in prices. Economists will make predictions about possible rates based on the current state of our economy however there are times when their predictions are not accurate. As a result of the change between predictions and what the rate actually is there are costs that result. These costs include , , loss of , and redistribution of wealth.

Costs of Inflation

result from a firm having to change prices. As occurs within our economy, businesses are forced to change any business-related materials that have prices on them like a menu as a result. An example of this would be Walmart having to hire additional workers to replace all the price tags on their products every week. Another example is the owner of a restaurant having to spend an extra three hours a week creating and updating coupons.

Shoe leather costs refer to the cost of time and effort that people end up spending to counteract the effects of . For example, businesses may hold less cash or have to make additional trips to the bank during . A good example of this is each month your rent increases so you can't set up an online automatic payment and as a result, have to pay cash and deliver the rent in-person to your landlord.

Loss of occurs because causes the value of the individual dollar to decrease over time. For example, individuals who have the same wage next year as they do currently will not be able to purchase as much. For example, if an individual earns a salary of $60,000 and the rate rises from 3% to 5% from 2018 to 2019 than that salary will not be able to purchase as much in 2019 as it was in 2018.

involves the real value of wealth being transferred from one group to another. (i.e. borrowers and lenders). When people are considering lending or borrowing money, they will take into consideration the expected rate. If that rate turns out to be different than anticipated, that affects the amount of interest that is repaid or earned.

Who Is Helped By Unanticipated Inflation?

While many think that is universally bad, actually helps people at times. Here are a few people who may be helped by :

Borrowers with : can benefit borrowers with because it can reduce the real value of the debt. For example, consider a borrower who takes out a loan with a fixed interest rate of 5% per year. If the rate is unexpectedly high and exceeds 5%, the real value of the debt will decline, effectively reducing the burden of the debt. Borrowers with , on the other hand, may not benefit from because their interest rates may increase to compensate for the higher .
Owners of assets: can also benefit owners of assets, such as real estate or stocks, because it can increase the nominal value of their assets. For example, if the rate is unexpectedly high, the nominal value of an asset may increase even if its real value does not change. This can lead to higher profits for asset owners.
Firms that can cut : can also benefit firms that can cut , as it can allow them to reduce the of their workers without reducing their . For example, if a firm is facing rising costs due to , it may be able to reduce the of its workers while maintaining their by adjusting for the higher rate. This can help the firm reduce its labor costs and improve its competitiveness.

It's important to note that is actually considered a good thing for the economy! incentivises spending because prices will be higher later. If we knew that prices were going to decrease, we wouldn't spend now, we'd wait.

Who is Hurt By Unanticipated Inflation?

1. Savers: can erode the of savings, as the money saved loses value over time due to rising prices. This can be particularly detrimental to those who rely on their savings for long-term financial stability, such as retirees. To protect against the effects of , savers may invest in assets that are expected to increase in value at a rate that is higher than the rate. These may include assets such as stocks, real estate, or certain types of bonds. Savers may also consider adjusting their saving strategies to account for the impact of on the real value of their savings.

2. Workers on fixed incomes: People who receive a fixed income, such as those on a pension or disability benefits, may find it difficult to keep up with rising prices if their income does not increase at the same rate as . This can lead to a decline in their standard of living.

3. Borrowers with variable rates: can also have negative effects on borrowers if their rates are variable. This is because will lead lenders to increase interest rates to pay for the costs of .

Here's a chart that summarizes some of the material we've covered:

Key Terms to Review (11)

Fixed Interest Rates

: Fixed interest rates refer to an interest rate that remains constant over a specified period of time, regardless of any changes in the market. It provides borrowers with stability and predictability in their loan repayments.

Inflation

: Inflation refers to the sustained increase in the general price level of goods and services in an economy over a period of time. It means that, on average, prices are rising and the purchasing power of money is decreasing.

Menu Costs

: Menu costs are the expenses incurred by firms when they need to change their prices due to factors such as inflation or other economic conditions. These costs include printing new menus, updating price tags, or modifying online listings.

Moderate Inflation

: Moderate inflation refers to a gradual and steady increase in the general level of prices over time. It is characterized by low and manageable rates of inflation that do not cause significant disruptions to an economy.

Nominal Wages

: Nominal wages refer to the amount of money a worker receives in their paycheck. It represents the actual dollar amount paid to an employee for their work.

Purchasing Power

: Purchasing power refers to the amount of goods and services that can be bought with a given amount of money. It is influenced by changes in prices and inflation.

Real Wages

: Real wages refer to the purchasing power of wages or income adjusted for inflation. It measures how much goods and services an individual can afford with their earnings.

Shoe-leather costs

: Shoe-leather costs refer to the increased expenses and inconveniences that individuals incur when they hold less money due to inflation. This includes the time and effort spent on frequent trips to the bank or ATM to withdraw smaller amounts of cash.

Unanticipated Inflation

: Unanticipated inflation refers to a sudden and unexpected increase in the general price level of goods and services in an economy. It occurs when the actual rate of inflation differs from what individuals and businesses had anticipated.

Variable Interest Rates

: Variable interest rates are interest rates that can fluctuate over time based on changes in market conditions such as inflation, economic growth, or central bank policies. Borrowers may experience changes in their monthly payments due to these fluctuations.

Wealth redistribution

: Wealth redistribution refers to the transfer of wealth, usually through government policies or programs, from one group or individual to another. The aim is to reduce economic inequality by reallocating resources and opportunities.

2.5 Costs of Inflation

5 min read•december 19, 2022

Jeanne Stansak

dylan_black_2025

Jeanne Stansak

dylan_black_2025

Costs of Inflation

Who Is Helped By Unanticipated Inflation?

While many think that is universally bad, actually helps people at times. Here are a few people who may be helped by :

Borrowers with : can benefit borrowers with because it can reduce the real value of the debt. For example, consider a borrower who takes out a loan with a fixed interest rate of 5% per year. If the rate is unexpectedly high and exceeds 5%, the real value of the debt will decline, effectively reducing the burden of the debt. Borrowers with , on the other hand, may not benefit from because their interest rates may increase to compensate for the higher .
Owners of assets: can also benefit owners of assets, such as real estate or stocks, because it can increase the nominal value of their assets. For example, if the rate is unexpectedly high, the nominal value of an asset may increase even if its real value does not change. This can lead to higher profits for asset owners.
Firms that can cut : can also benefit firms that can cut , as it can allow them to reduce the of their workers without reducing their . For example, if a firm is facing rising costs due to , it may be able to reduce the of its workers while maintaining their by adjusting for the higher rate. This can help the firm reduce its labor costs and improve its competitiveness.

Who is Hurt By Unanticipated Inflation?

3. Borrowers with variable rates: can also have negative effects on borrowers if their rates are variable. This is because will lead lenders to increase interest rates to pay for the costs of .

Here's a chart that summarizes some of the material we've covered:

Key Terms to Review (11)

Fixed Interest Rates

Inflation

Menu Costs

Moderate Inflation

Nominal Wages

: Nominal wages refer to the amount of money a worker receives in their paycheck. It represents the actual dollar amount paid to an employee for their work.

Purchasing Power

: Purchasing power refers to the amount of goods and services that can be bought with a given amount of money. It is influenced by changes in prices and inflation.

Real Wages

: Real wages refer to the purchasing power of wages or income adjusted for inflation. It measures how much goods and services an individual can afford with their earnings.

Shoe-leather costs

Unanticipated Inflation

Variable Interest Rates

Wealth redistribution