Inflation hurts savers, lenders and people on fixed incomes, can help borrowers, and makes a country's exports less competitive.
Savers lose if the interest rate on their savings is lower than inflation. Their money buys less when they spend it. Lenders lose for the same reason: the money repaid is worth less than the money lent.
Borrowers can gain, because they repay debts with money that is worth less. A fixed loan repayment becomes easier to pay as wages rise with inflation.
Consumers lose if their incomes rise more slowly than prices, so their real income falls. Workers on fixed wages, and retirees on fixed pensions, are hit hardest. Workers in strong bargaining positions may win pay rises to keep up.
Firms face uncertainty, so they may delay investment. They must spend time and money changing prices. If inflation is higher than in other countries, exports become less competitive and imports more attractive. Low, stable inflation does little harm, but high or unpredictable inflation is damaging.
- Savers and lenders
- Lose if inflation exceeds the interest rate.
- Borrowers
- May gain: debts are repaid with money worth less.
- Fixed incomes
- Real income falls.
- Economy
- Uncertainty, menu costs, less competitive exports.
Worked example: Real value of savings
Suppose you save $1,000 at 1% interest while inflation is 4%.
- After a year you have $1,010.
- But goods that cost $1,000 now cost $1,040.
- Your savings buy about 3% less than before: you have lost real value.
- A borrower who owes a fixed $1,000 gains in the same way: the debt is worth less in real terms.
Watch out for this
Inflation harms everyone equally.
Inflation shifts wealth between groups. Savers, lenders and people on fixed incomes lose; borrowers may gain; workers whose pay keeps up are less affected.
Check your understanding
Inflation is 5% and a savings account pays 2% interest. What happens to savers?
- The real value of their savings falls.
- They gain because they earn interest.
- They are unaffected.