Multiple Choice
Which group is most likely to be harmed if investors fear rising inflation and nominal interest rates increase?
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11. Unemployment and Inflation
Who is Affected by Inflation?
Multiple Choice
Who is most directly exposed to inflation risk (the risk that rising prices reduce the real purchasing power of fixed dollar payments)?
A
A retiree receiving a fixed nominal pension payment each month
B
A worker whose wages are automatically indexed to the Consumer Price Index (CPI)
C
A borrower with a fixed-rate student loan who experiences higher-than-expected inflation
D
A homeowner with a 30-year fixed-rate mortgage who unexpectedly experiences higher inflation
Verified step by step guidance1
Step 1: Understand what inflation risk means. Inflation risk refers to the possibility that rising prices will erode the real value or purchasing power of fixed nominal payments over time.
Step 2: Identify which parties receive fixed nominal payments. A retiree receiving a fixed nominal pension payment each month gets a set amount of money that does not adjust with inflation.
Step 3: Consider how inflation affects each option. For example, a worker whose wages are indexed to the CPI will have wages adjusted upward with inflation, protecting their real income.
Step 4: Analyze the impact of inflation on borrowers and homeowners with fixed-rate loans. Higher inflation reduces the real value of fixed-rate debt payments, which can actually benefit borrowers by lowering the real cost of their debt.
Step 5: Conclude that the retiree with fixed nominal payments is most directly exposed to inflation risk because their income does not increase with rising prices, reducing their real purchasing power.
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