Who is most likely to be harmed by unexpected inflation?

• A. A household that is a net borrower with a long-term fixed-rate mortgage
• B. A worker whose wages are fully indexed to the consumer price index (CPI)
• C. A household that is a net lender holding long-term fixed-rate bonds
• D. A firm that can immediately raise its product prices one-for-one with the overall price level

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. This affects the real value of money, debts, and contracts that are fixed in nominal terms.
2. Step 2: Analyze the impact of unexpected inflation on borrowers and lenders. Borrowers benefit because they repay their debts with money that is worth less than expected, while lenders lose because the money they receive back has less purchasing power.
3. Step 3: Consider the case of a household that is a net borrower with a long-term fixed-rate mortgage. Since the mortgage payments are fixed in nominal terms, unexpected inflation reduces the real value of these payments, benefiting the borrower.
4. Step 4: Consider a worker whose wages are fully indexed to the CPI. Since their wages adjust automatically with inflation, unexpected inflation does not harm them because their real income remains stable.
5. Step 5: Consider a household that is a net lender holding long-term fixed-rate bonds. Because the payments they receive are fixed in nominal terms, unexpected inflation reduces the real value of these payments, harming the lender. This is why this household is most likely to be harmed by unexpected inflation.