Question

7. Suppose that people expect inflation to equal 3%, but in fact, prices rise by 5%. Describe how this unexpectedly high inflation rate would help or hurt the following: 1. the government 2. a homeowner with a fixed-rate mortgage 3. a union worker in the second year of a labor contract 4. a college that has invested some of its endowment in government bonds

Answer 1

The answer is:

1. Help

2. Help

3. Hurt

4. Hurt

Step-by-step explanation:

1. Help. This unxpected increase in inflation will help the government because this will increase its revenue and also reduce the real value of government outstanding debts.

2. Help. Paying at a fixed rate that was agreed when the interest rate was 3percent will be of help with the home owners because the real interest rate he will be paying lower. The lenders lose during this period.

3. Hurt. It will hurt this worker because the contract was agreed when the interest rate was 3percent. Now that prices of goods and services have increased, purchasing power will be reduced.

4. Hurt. Because with increased inflation, interest rates will be lower. So the college is earning lower interest rate.