Question

Suppose that people expect inflation to equal 3% but instead prices rise by 5%. Which of the following parties would be helped by this unexpectedly high inflation?

a. the government
b. a homeowner with a fixed-rate mortgage
c. a union worker in the second year of a labor contract d. a college that has invested some of its endowment in government bonds

Answer 1

Answer: b. a homeowner with a fixed-rate mortgage

Step-by-step explanation:

Inflation erodes the value of money such that $1 today is stronger than $1 a year from now. When mortgage rates are calculated, they take into account the expected inflation rates so that the interest payments will not be smaller than they should be as inflation increases.

If inflation increases more than it was expected to have increased therefore, a person paying a fixed rate would benefit because they would be paying less in effect on account of inflation having made their payments weaker.