The Fed announced that prices would be rising by 3 percent. However, due to unex

Question

The Fed announced that prices would be rising by 3 percent. However, due to unexpected surges in demand, prices rose by 5 percent. How would this unexpected inflation rate help, hurt, or not impact each of the following? Fully explain your answers. (10 pts)

1. A homeowner with a fixed-rate mortgage. [2.5 pts]

2. A union worker in the third year of a five-year labor contract. [2.5 pts]

3. A student with a variable- and deferred-interest loan tied to inflation. [2.5 pts]

4. A retiree primarily living off of her mutual-fund-invested 401(k). [2.5 pts]

Explanation / Answer

Answer 1:-

This unexpected inflation will help the homeowner with a fixed rate mortgage, as when inflation will occur the real value of money will decrease and since the homeowner will be paying a fixed rate mortgage the real value of his payment will decrease.

Answer 2:-

This unexpected inflation will hurt the union worker in the third year of a five-year labor contract because labour contracts are made keeping in mind the expected inflation. This sudden unexpected inflation will make things costlier for the labour as his wages will not increase simultaneously and the current wage he is getting will get reduced in real value. This is also called as sticky price.

Answer 3:-

This unexpected inflation will not impact the student with a variable- and deferred-interest loan tied to inflation as the interest rate on his deferred interest rate loan will change with inflation. Thus real value of money paid by him as interest and loan will remain same for him.

Answer 4:-

This unexpected inflation will hurt a retiree primarily living off of her mutual-fund-invested as although the prices of consumer goods will increase due to sudden inflation the returns on mutual funds will not. Therefore the real value of return received on mutual fund will decrease.

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