The Federal government and introductory econ textbooks tend to side with lenders in the dispute between lenders and borrowers over inflation. They focus on the problems inflation causes for lenders and the economy through uncertainty and uneven price increases, emphasizing the "evils of inflation."

1. Inflation

2. Inflation
Defined as:
– A SUSTAINED RISE IN THE AVERAGE
LEVEL OF PRICES

3. Types of Inflation
• DEMAND PULL
• WAGE PUSH
• PROFIT PUSH.

4. Types of Inflation
A. DEMAND PULL
Defined as:
- Excess demand pulls up prices
• Often caused by increases in government
spending, such as wars

5. Types of Inflation
B. WAGE PUSH
Defined as:
- attempts to increase wages faster than
productivity
• Often blamed on unions

6. Types of Inflation
C. PROFIT PUSH
Defined as:
- attempts to increase profits by raising
prices
• Often blamed on large corporations

7. Problems with Inflation
• There are two problems generated by
inflation.
C. UNEVENESS
E. UNCERTAINTY

8. Problems with Inflation
A. UNEVENESS
– Inflation produces uneven increases in the
prices of products.
– In periods of inflation it is possible of have
some products decrease in price, others
increase slowly, while others increase
quickly.

9. Problems with Inflation
A. UNEVENESS
– This means that some consumers are hurt
worse than others.
– Buyers of gasoline are hit worse than buyers
of DVD’s and computers

10. Problems with Inflation
A. UNEVENESS
– People with fixed incomes will see their
income fall at the same rate as inflation rises.
– Some savers will see their savings fall almost
as fast as the rate that inflation

11. Problems with Inflation
A. UNCERTAINTY
Who else is hurt by the uncertainty and
unevenness of inflation?
Lenders – banks, etc.

12. Problems with Inflation
B. UNCERTAINTY
– Lenders lend money to earn a profit.
– To earn a profit, the interest they charge must
cover all costs, and be higher than the rate of
inflation.

13. Problems with Inflation
B. UNCERTAINTY
– When lenders lend money, they have an
expected rate of inflation at the time of the
loan.
– This expected rate of inflation is based on
current rate of inflation, plus a guess about
the future.

14. Problems with Inflation
B. UNCERTAINTY
– If lenders guess right about inflation, they
earn a profit.
– If lenders guess wrong, they lose money.

15. Problems with Inflation
A. UNCERTAINTY
Nominal interest rate = the observed interest
rate
Real interest rate = nominal interest rate –
rate of inflation

16. Problems with Inflation
A. UNCERTAINTY
Lenders try to set the nominal interest rate to:
1) cover costs
2) match expected rate of inflation
3) yield a profit

17. Inflation: Any Winners?
Not everyone loses with low and moderate
rates of inflation.
- People whose income is flexible.
- Borrowers (debtors).

18. Inflation: Any Winners?
Borrowers win because the real value of their
loan repayments decreases at the same
rate as inflation rises.
If their incomes rise as well, they are double
winners.

19. Problems with Inflation
Much of the United States Federal
government’s monetary policy, and the
focus of most introductory econ
textbooks, is on the evils of inflation.
In the dispute between lenders and
borrowers, which side are they on?