2.5 Costs of Inflation
Unanticipated inflation redistributes wealth, borrowers with fixed rates gain, lenders and savers lose, and adds menu, shoe-leather, and uncertainty costs.
The big cost of UNANTICIPATED inflation is redistribution. Borrowers with fixed nominal interest rates win because they repay in dollars worth less than expected; lenders, savers, and anyone on a fixed income lose. The logic runs through real rate ≈ nominal rate − inflation: surprise inflation shrinks the real rate actually paid.
Even anticipated inflation has costs: menu costs (constantly reprinting prices), shoe-leather costs (extra trips and effort to avoid holding cash that loses value), and distorted price signals that make planning and long-term contracts harder.
The key exam distinction is anticipated versus unanticipated. If everyone correctly expects 5% inflation, lenders build it into nominal rates and nobody is fooled; the arbitrary winners and losers appear only when actual inflation differs from what was expected.
Key terms for 2.5
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Reversing the winners: saying lenders gain from unanticipated inflation. Lenders locked into fixed nominal rates get repaid in cheaper dollars, borrowers gain, lenders and savers lose.
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