Multiple Choice
Which group is most likely to benefit from an unexpected increase in inflation (surprise inflation)?
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11. Unemployment and Inflation
Who is Affected by Inflation?
Multiple Choice
Which group is most likely to be harmed if investors fear rising inflation and nominal interest rates increase?
A
Workers whose wages are fully indexed to inflation, because their real wages fall when prices rise
B
Firms with strong pricing power that can raise prices as fast as inflation, because their real revenues decline
C
People who owe fixed-rate debt, because higher inflation increases the real burden of their repayments
D
People holding long-term fixed-rate bonds, because higher inflation expectations raise nominal interest rates and push existing bond prices down
Verified step by step guidance1
Step 1: Understand the relationship between inflation expectations and nominal interest rates. When investors expect higher inflation, nominal interest rates tend to rise to compensate for the loss of purchasing power over time.
Step 2: Recognize how rising nominal interest rates affect bond prices. Since bond prices and interest rates move inversely, an increase in nominal interest rates causes the prices of existing fixed-rate bonds to fall.
Step 3: Identify the group holding long-term fixed-rate bonds. These investors receive fixed payments that do not adjust for inflation, so when inflation rises, the real value of their returns decreases.
Step 4: Compare this with other groups: workers with wages indexed to inflation maintain their real wages, firms with pricing power can adjust prices to keep revenues stable, and people with fixed-rate debt benefit because inflation reduces the real value of their repayments.
Step 5: Conclude that the group most harmed by rising inflation expectations and nominal interest rates are holders of long-term fixed-rate bonds, as their bond prices fall and real returns decline.
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