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This is why inflation can create a “huge wealth transfer” from lenders to borrowers.

taller than price For car rentals, plane tickets and uncooked beef roasts wonder if economists and consumers are alive until the beginning of the inflationary era.

It is not yet known if these price increases are correct. Temporary blip Monthly price increases across a wide range of goods and services due to supply-demand mismatches or signs of inflation in the pandemic era. If the latter is true, at least one demographic may benefit from this trend. In other words, anyone with fixed rate debt, including consumers and governments.

“Inflation could be the transfer of this huge wealth from lenders to borrowers,” said Kent Smetters, faculty director of the Penwalton budget model, which analyzes the impact of public policy proposals on budgets and the economy. Said. “Many lenders are rich people and many borrowers are non-rich people. It is the lenders who take a little bath and the borrowers will get a discount on what they have to repay.”

Here’s how this works.

Consumer wealth will increase and liabilities will decrease

Under all that, rising wages drive a period of inflation. As prices rise, companies rush to hire more workers to produce more goods and make the rise in prices available. This increase in wages will cause businesses to charge more for their products. After that, workers demanded higher wages and a spiral could occur, which has not been seen since the 1970s.

As a result, the unit of money is essentially less valuable than it used to be. However, consumers who borrow a fixed-rate loan before the start of the inflation period are only obliged to repay the amount they originally agreed to.

The group of borrowers is “lucky,” Smetters said. “You will repay the loan with less purchasing power than you borrowed.” In other words, these borrowers spend less money to repay their loans than they did when they borrowed the loan.

There are major categories of consumer loans that can benefit from this dynamics.Fixed-rate federal student loans, fixed-rate private student loans (some private student loans use floating rates and fluctuate with inflation) and fixed-rate Housing loan..

“If you’re a borrower with a fixed-rate 30-year mortgage, it’s a classic inflation hedge,” Smetters said. “Maybe your home price will catch up with inflation at least a little, but your fixed rate loan will not change.”

Student loans work as well. Theoretically, the borrower’s wages rise with inflation, but the amount borrowed on the student loan does not change.

“Your assets,” in this case your workforce or human capital, are “essentially catching up with inflation,” Smetters said. “But your debt, or your student’s debt, has been wiped out, not completely, but it’s still declining due to inflation.”

Still, inflation isn’t all good news for new borrowers. In the future, anyone taking a fixed rate loan may face high interest rates with inflation prices. Inflation causes economic volatility, which can increase the risk that even borrowers benefiting from the cheaper dollar will face unemployment and other challenges. To.

Moreover, even if borrowers benefit from a period of inflation, they may not see it that way.

“People’s views on whether inflation is good for them tend to deviate from the way economists think about it,” said Jesse Schlegger, an associate professor of economics at Columbia Business School.

When economists think about inflation, they assume that as prices go up, so do wages. But when consumers, workers, and borrowers think about it, they often don’t take into account that their wages may rise, that they probably only internalize price increases. Means.

“It’s not immediately clear if the people I want to say most really want to benefit from inflation,” he said.

The government will give creditors less real

Not only individual borrowers can benefit from inflation, but also debt-bearing governments. In fact, historically, some governments have forced central banks to increase the money supply and devalue each unit of the country in order to devalue the country’s debt, essentially causing inflation. It was.

This is not the strategy adopted by the US monetary policymaker, whose Federal Reserve closely monitors inflation to stabilize prices. (The Fed balances this goal with other missions to keep employment relatively high.) Still, the U.S. government can benefit from inflation, at least as far as the value of debt is concerned. ..

“The higher the inflation rate, the less realistic the US government will give creditors when paying back,” Schlegger said. Another way to look at it is that the US economy, which has to spend taxes to pay off its debts, will have a lower share of output and higher inflation, he said.

Inflation can “actually undermine the value of government debt,” even a modest and sustained rise in inflation, according to Schlegger.

“It’s really easy for the government to pay off debt when there is inflation that the market didn’t expect when the debt was issued,” he said. For example, a person who bought 10 or 30 year government bonds three years ago probably didn’t price the risk of inflation.

Still, inflation poses a risk to government priorities. If prices and wages are too high, the Fed may try to curb inflation. Central banks do this by raising short-term interest rates to discourage corporate, consumer and government investment.

It could block future government investment and boost interest rates on new money borrowed by the government. The latter could pressure the government to find more resources to repay new loans, either through tax increases or spending cuts.

This is why inflation can create a “huge wealth transfer” from lenders to borrowers. This is why inflation can create a “huge wealth transfer” from lenders to borrowers.

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