Which group is helped by inflation if nominal interest rate does not change?
a) debtors
b) creditors
c) restaurant owners who must reprint menus
d) senior citizens on a fixed income
The correct answer and explanation is:
The correct answer is a) debtors.
Explanation:
Inflation benefits debtors when the nominal interest rate does not change. This is because inflation erodes the real value of money over time. When prices rise, the purchasing power of money decreases, meaning that the money a debtor repays is worth less than the money originally borrowed. In simple terms, the debtor is paying back the loan with money that has less value than when they initially borrowed it, which effectively reduces the burden of the loan.
For example, if a person borrows $1,000 with a fixed interest rate and inflation causes the value of money to drop, the debtor repays the loan with $1,000 that is worth less in real terms. Even though the nominal interest rate stays the same, inflation means that the real interest rate (which accounts for inflation) is lower. This favors debtors because the effective cost of borrowing declines.
On the other hand, creditors are hurt by inflation in this situation. Since they are paid back in money that is worth less, the real value of the repayments they receive is reduced. This means creditors get less purchasing power than they originally expected.
Restaurant owners who must reprint menus or senior citizens on a fixed income are also negatively affected by inflation. Reprinting menus adds costs, and senior citizens with fixed incomes find it harder to afford rising prices, as their income does not adjust with inflation.
In summary, when nominal interest rates do not change during inflation, debtors are the group that benefits because the real value of the money they repay decreases.