Asked Oct 16, 2019

Question. Suppose that people expect inflation to equal 3 percent, but in fact prices rise by 5 percent. Indicate whether this unexpected higher rate of inflation would help or hurt each of the following groups.

    1. a homeowner with a fixed-rate mortgage.
    2. a union worker with a fixed labor contract
    3. a company that has invested some of its endowment in government bond which pay fixed rate of return.

Expert Answer

Step 1

The inflation is the abnormal increase in the general price level in the economy. When there is inflation in the economy, the value of money decreases which means that more money will be needed to purchase the commodities from the market than before. So, when there is inflation in the economy, too much of money would be able to chase a too few goods from the market.

Step 2


When there is expected inflation rate of 3 percent, people would expect the inflation to be of 3 percent and would adjust their inflation expectations and other expectations on the basis of this expected inflation rate. When the actual increase is by 5 percent, it means that the actual inflation is higher than the anticipated level in the economy. The home owner with a fixed rate mortgage will be beneficial with the inflation as the fixed rate would means that the homeowner is paying a fixed nominal interest rate which was determined on the basis of expected inflation.

Step 3


The union workers will have long term wage contracts which ensure the wages of the workers in the economy with the employer. Thus, the increase in the wages will not be possible when the long term contracts are operational in the economy. The wage contracts would have been framed on the basis of the expected i...

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