People with savings held in fixed nominal assets (e.g., cash or a fixed-interest bank deposit) are often hurt by inflation. Which statement best explains why?

• A. Inflation automatically increases the real value of their nominal savings because prices rise faster than wages.
• B. Inflation reduces the real purchasing power of their nominal savings, so the same dollar amount buys fewer goods and services.
• C. Inflation primarily hurts savers because it lowers the nominal interest rate they earn to zero by law.
• D. Inflation hurts savers only if they hold savings in assets whose values are indexed to inflation.

Answer: (B)

Verified step by step guidance

1. Step 1: Understand the difference between nominal and real values. Nominal value refers to the face value of money or assets without adjusting for inflation, while real value accounts for changes in purchasing power due to inflation.
2. Step 2: Recognize that inflation means a general increase in prices over time, which reduces the purchasing power of money. This means that each dollar can buy fewer goods and services than before.
3. Step 3: Analyze how fixed nominal assets, such as cash or fixed-interest bank deposits, are affected by inflation. Since their nominal value does not change, inflation erodes their real value because the same amount of money buys less.
4. Step 4: Understand that inflation does not automatically increase the real value of nominal savings; instead, it decreases it unless the interest rate on savings compensates for inflation (which is often not the case with fixed nominal assets).
5. Step 5: Conclude that the best explanation is that inflation reduces the real purchasing power of nominal savings, meaning the saver’s money loses value in terms of what it can buy, which is why savers are hurt by inflation.