Final answer:
The cost of money is affected by time preferences for consumption, risk, and inflation, with inflation typically harming lenders by reducing the value of repayments. Fixed income individuals suffer from inflation as it reduces purchasing power, and a decrease in expected interest rates affects individual budget constraints and influences consumption/saving decisions.
Step-by-step explanation:
The cost of money is influenced by various fundamental factors, including time preferences for consumption, risk, and inflation. Each of these factors plays a crucial role in determining interest rates and the overall cost of borrowing money.
Inflation typically hurts lenders more because the value of the money they get back is less than it was at the time of lending due to the decrease in purchasing power. For instance, if a government has borrowed money and inflation rises unexpectedly, the amount they pay back is essentially less valuable, which benefits them.
Those on a 'fixed' income, like retirees on Social Security benefits, are negatively impacted by inflation as their income doesn't increase at the same rate as the cost of living, reducing their purchasing power. Regarding interest rates, a decrease in expected interest rates would likely cause an individual to adjust their intertemporal budget constraint, which could affect their consumption/saving decision.
Finally, when economists calculate an interest rate, they account for the compensation for delaying consumption, an adjustment for an expected increase in the level of prices due to inflation, and a risk premium based on the borrower's creditworthiness.