What this lesson teaches
I can explain how these macroeconomic problems hurt households, firms and governments.
Syllabus 9570, 3.2.2(b). Macroeconomic Issues: Consequences of undesirable economic growth, unemployment, price instability, persistently large balance of trade deficit or surplus for economic agents on the standard of living
Make a guess
Prices rise 10% unexpectedly. Who is most likely to gain?
- A borrower repaying a fixed sum of money.
- A retiree living on a fixed pension.
- A saver keeping cash in a low-interest account.
Show the answer
A borrower repaying a fixed sum of money.
The repayment is fixed in dollars but now buys less. In real terms, the borrower repays less than they borrowed.
Inflation hurts people on fixed incomes and savers, and can help borrowers; high inflation also harms competitiveness.
Inflation reduces purchasing power when incomes do not keep up with prices. Retirees on fixed pensions and low-wage workers are hit hardest.
Unexpected inflation redistributes wealth. Borrowers repay loans with money that buys less, so they gain; lenders and savers lose, unless interest rates rise to match.
For Singapore, higher inflation than trading partners makes exports dearer and less competitive.
Uncertainty about future prices makes firms less willing to invest. Mild, stable inflation is less harmful than high or unpredictable inflation.
- Losers
- Fixed-income earners, savers, lenders.
- Gainers
- Borrowers with fixed repayments.
- Singapore
- Higher inflation hurts export competitiveness.
Worked example: A fixed pension and a fixed loan
A pension is fixed at $1,000 a month. A basket of essentials rises from $100 to $110. Separately, a borrower owes a fixed $1,100, and the price rise was unexpected.
- The pension buys 10 baskets before and about 9.1 after: its real value fell.
- The $1,100 repayment is worth about 10 baskets instead of 11, so the borrower gains.
- The lender receives less in real terms, so the lender loses.
- Whether the borrower is better off overall also depends on what happened to their income.
Watch out for this
Inflation makes everyone worse off.
People whose incomes rise faster than prices, and borrowers with fixed repayments, can gain.
Check your understanding
A saver earns 2% interest a year while inflation runs at 5%. What happens to the real value of her savings?
- It falls by about 3% a year.
- It rises by about 2% a year, the interest earned.
- It rises by about 7%, interest plus inflation.
Show the answer
It falls by about 3% a year.
Right. The real return is about 2% - 5% = -3%, so her savings buy less each year.