Question

Hey everyone!

I'm really confused on how to answer this question:

True or False: If both, a lender and a borrower correctly anticipate inflation, inflation will redistribute wealth from the borrower to the lender. You must provide an explanation to earn marks.


I think it has something to do with real and nominal interest rates.. but the question doesn't really make sense. Would it depend on the situation due to Banks not considering inflation but some other institutions may consider it?

Please help,

Thank you for your time,

A Stumped Student.

Answer 1

It's basically saying, that if inflation occurs, as expected, lender will now be more "wealthy" than the borrower before the inflation began.

That's how I view it anyway...
So I'd go with false, as since prices rise (in times of inflation), the current value and/or interest that the borrower will have to repay the lender is less than the original value her borrowed, as now $60 is worth less than before, as the value of currency declines too.

I hope that helps!! :)