Who is most likely to benefit from unexpected inflation?

• A. A retiree living on a fixed nominal pension that does not adjust for inflation
• B. A lender receiving fixed nominal interest payments on a long-term bond
• C. A household with a fixed-rate mortgage (a fixed nominal debt) whose income rises with prices
• D. A worker with a long-term contract that fixes nominal wages for several years

Answer: (C)

Verified step by step guidance

1. Step 1: Understand the concept of unexpected inflation. Unexpected inflation occurs when the actual inflation rate is higher than what people anticipated when making financial decisions, such as lending or wage contracts.
2. Step 2: Analyze the impact of unexpected inflation on fixed nominal payments. For example, a retiree with a fixed nominal pension or a lender receiving fixed nominal interest payments will see the real value of their income decline because inflation erodes purchasing power.
3. Step 3: Consider the case of a household with a fixed-rate mortgage (fixed nominal debt). Since their debt payments remain constant in nominal terms, but their income rises with inflation (prices), the real burden of their debt decreases, benefiting them.
4. Step 4: Evaluate the situation of a worker with a long-term contract fixing nominal wages. If inflation is unexpectedly high, their real wages decline because their nominal wages do not adjust, making them worse off.
5. Step 5: Conclude that the group most likely to benefit from unexpected inflation is the household with fixed nominal debt whose income rises with prices, as inflation reduces the real value of their debt payments while their income increases.