Which group is most likely to benefit from an unexpected increase in inflation (surprise inflation)?

• A. Borrowers with fixed-rate debt, because the real value of what they repay falls
• B. Workers on long-term nominal wage contracts, because their real wages rise automatically
• C. Lenders who made fixed-rate loans, because the real value of repayments rises
• D. Retirees receiving fixed nominal pensions, because their purchasing power increases

Answer: (A)

Verified step by step guidance

1. Step 1: Understand the concept of unexpected or surprise inflation. It occurs when the actual inflation rate is higher than what people anticipated when making financial decisions.
2. Step 2: Recall that inflation reduces the real value of money over time. This means that if you owe money (borrowers), the amount you repay in the future is worth less in real terms if inflation is higher than expected.
3. Step 3: Analyze each group: Borrowers with fixed-rate debt benefit because they repay with money that is less valuable than expected, effectively reducing their real debt burden.
4. Step 4: Workers on long-term nominal wage contracts do not automatically benefit because their wages are fixed in nominal terms and do not adjust immediately to inflation, so their real wages typically fall with unexpected inflation.
5. Step 5: Lenders with fixed-rate loans and retirees with fixed nominal pensions lose out because the real value of repayments and pensions decreases, reducing their purchasing power.