How does inflation redistribute income from savers to borrowers

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This cookie is used for marketing and advertising. When inflation is anticipated individuals take actions to protect themselves from the effects of inflation. Because inflation erodes the purchasing power of money people devote more resources to reducing money holdings and fewer resources to the production of goods and services. Unanticipated inflation benefits government because government is a large debtor.

Unanticipated inflation benefits government because government gains tax revenue as nominal income increases. The increase' in nominal income pushes people into higher tax brackets. To prevent this redistribution of income, the personal income tax system is now indexed; however, the rest of the federal tax system is not.

Thus, inflation lets debtors pay lenders back with money that is worth less than it was when they originally borrowed it. Inflation can help lenders in several ways, especially when it comes to extending new financing. First, higher prices mean that more people want credit to buy big-ticket items, especially if their wages have not increased—this equates to new customers for the lenders.

On top of this, the higher prices of those items earn the lender more interest. If prices increase, so does the cost of living. If the people are spending more money to live, they have less money to satisfy their obligations assuming their earnings haven't increased. With rising prices and no increase in wages, the people experience a decrease in purchasing power. As a result, the people may need more time to pay off their previous debts allowing the lender to collect interest for a longer period.

However, the situation could backfire if it results in higher default rates. Default is the failure to repay a debt, including interest or principal on a loan.

When the cost of living rises, people may be forced to spend more of their wages on nondiscretionary spending, such as rent, mortgage, and utilities. This will leave less of their money for paying off debts, and borrowers may be more likely to default on their obligations. If inflation is rising against the backdrop of a growing economy, this may result in central banks, such as the Federal Reserve, increasing interest rates to slow the rate of inflation.

Higher interest rates may lead to a slowdown in borrowing as consumers take out fewer loans. However, the rise in interest rates can help lenders earn more profits, particularly variable-rate credit products such as credit cards.

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