Question

Which of the following statements is correct regarding inflation and deflation?

A. Borrowers benefit from deflation as the value of their debt decreases in real terms.
B. Inflation transfers wealth from lenders to borrowers.
C. Falling prices benefit consumers and are therefore always good for the economy.
D. Inflation makes it difficult for consumers and firms to attain the message about scarcity of resources (sent by relative prices) and is therefore always bad for the economy.

Answer 1

The correct statement regarding inflation and deflation is that inflation transfers wealth from lenders to borrowers, as borrowers can pay off their debts with money that has less purchasing power.

Step-by-step explanation:

The question deals with the concepts of inflation and deflation and how they affect different entities in an economy, such as borrowers, lenders, and consumers. To address the question, we need to look at each statement in turn:

• B. This is the correct statement. During periods of inflation, borrowers benefit because they can repay their loans with money that is worth less than when they borrowed it, effectively reducing the real value of the debt. This is an example of the wealth transfer from lenders to borrowers.
• A. This statement is incorrect. In deflation, the value of currency increases, making debtors pay back with more valuable dollars, harming borrowers.
• C. While consumers may benefit from lower prices in the short term, persistent deflation can harm the economy by reducing consumer spending and leading to lower production and higher unemployment rates.
• D. Inflation may obscure the signals of scarcity sent by prices, but it is not 'always bad' for the economy, as moderate inflation is a normal part of many healthy economies.

Thus, Option B is the correct statement: Inflation transfers wealth from lenders to borrowers.