Economics – Government and the macroeconomy - Inflation | e-Consult

(a) Inflation erodes the purchasing power of money. This means that the real value of money held by savers decreases. Savers benefit if the interest rate on their savings is higher than the inflation rate, as their real return increases. However, if the interest rate is lower than the inflation rate, their real return is negative, meaning they lose purchasing power.

Lenders are negatively affected by inflation. They receive repayments in money that is worth less than when they originally lent it. The real return on their loans decreases. To compensate for this, lenders typically demand a higher nominal interest rate, which can make borrowing more expensive.

Borrowers benefit from inflation. They repay their loans with money that has less purchasing power than when they borrowed it. This effectively reduces the real cost of borrowing. However, borrowers are disadvantaged if the interest rate on their loans is lower than the inflation rate, as they are repaying with money of lower real value.