Question

An unanticipated inflation would cause

• A. redistribution of wealth from lenders to borrowers
• B. redistribution of wealth from borrowers to lenders
• C. gains for both borrowers and lenders
• D. losses for both borrowers and lenders

Hint:

Remember: Unexpected inflation benefits borrowers and hurts lenders. The higher the surprise inflation, the greater the wealth transfer to borrowers.

Answer 1

The Correct Option is A

Step 1: Understanding unanticipated inflation.
Unanticipated inflation means actual inflation exceeds what was expected when contracts were made. This changes the real value of repayments.
Step 2: Impact on lenders and borrowers.
Borrowers repay loans with money that has less purchasing power than anticipated. Thus, lenders receive less in real terms, while borrowers benefit.
Step 3: Analyzing the options.
(A) Correct — unexpected inflation benefits borrowers at the expense of lenders.
(B) Incorrect — this happens when inflation is lower than expected (deflationary situation).
(C) Incorrect — both cannot gain simultaneously; it’s a redistribution.
(D) Incorrect — total wealth is redistributed, not lost by both sides.

Step 4: Conclusion.
Unanticipated inflation causes a transfer of wealth from lenders to borrowers because debt is repaid in less valuable money.