Advanced Personal Finance

Who wins and who loses when inflation shows itself? It’s a question that at first might seem pointless or even stupid. Inflation sucks for everyone, right?

Not so fast. It turns out, inflation is good for some and bad for others. It doesn’t affect everyone equally. People usually focus on the bad, I think, because we tend to focus on the cost of things we buy frequently. When a gallon of milk cost $2.69 a month ago and now costs $2.99 - that’s inflation and it’s bad.

Who wins with higher inflation:

• People with fixed-rate loans. People with fixed-rate loans like mortgages and car loans enjoy a benefit when inflation rises. If you think about it, they’re paying off their loan with dollars that are worth less than the ones they borrowed. Assuming you do something productive (like buy a house) with the money you borrowed, you benefit from higher inflation.

• Companies that produce ‘expendables.’ When inflation rises, it makes sense to spend money as fast as you can. You get more product today than you will tomorrow. So any company that makes a product that is non-durable is going to do better than one that produces something people buy infrequently, especially if demand is elastic.

• The U.S. government. Ah, yes, the originators of inflation. As I explained in an earlier post, the Fed generates inflation through its creation of money. As the biggest borrower ever, it is the ultimate beneficiary of inflation. As inflation rises, the federal government pays less in ‘real’ money to cover its debts.

Who loses:

• Those on fixed incomes. Anyone who is paid a fixed amount of money will get killed during periods of high inflation. Even if their payment is indexed to inflation, the reset typically only comes once or twice a year.

• Lenders and savers. Inflation pinches lending for the reason cited above. And anyone who actually saves money will also be hurt as their purchasing power erodes.

• First time home buyers. Anyone trying to get a loan faces a key obstacle during periods of high inflation. Interest rates will be higher as lenders attempt to get compensation for the inflation risk. This alone can price people out of the market for a new home.

So though at first it seems like a silly question, inflation most definitely affects people differently. The biggest losers are those on fixed incomes and the biggest winner is the U.S. government.

Source: Bureau of Labor Statistics, Consumer Price Indexes

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This entry was posted on Tuesday, June 19th, 2007 at 8:16 am and is filed under Inflation. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.