The major distributional impact of inflation arises from differences in the kinds of assets and liabilities that people hold. When people owe money, a sharp rise in prices is a windfall gain for them. Suppose you borrow $100,000 to buy a house and your annual fixed interest rate mortgage payments are $10,000. Suddenly, a great inflation doubles all wages and incomes. Your nominal mortgage payment is still $10,000 per year, but its real cost is halved. You will need to work only half as long as before to make your mortgage payment. The great inflation has increased your wealth by cutting in half the real value of your mortgage debt.
This kind of thinking is a common feature of speculative real estate bubbles, for example, when land prices rose sharply in the 1920s and 1970s, people borrowed heavily to buy houses or farmland. Then, when inflation slowed and the economy turned sour, the mortgage payments were so burdensome that thousands of people went bankrupt.
If you are a lender and have assets in fixed interest rate mortgages or long term bonds, the shoe is on the other foot. An unexpected rise in prices will leave you the poorer because the dollars repaid to you are worth much less than the dollars you lent.
This kind of thinking is a common feature of speculative real estate bubbles, for example, when land prices rose sharply in the 1920s and 1970s, people borrowed heavily to buy houses or farmland. Then, when inflation slowed and the economy turned sour, the mortgage payments were so burdensome that thousands of people went bankrupt.
If you are a lender and have assets in fixed interest rate mortgages or long term bonds, the shoe is on the other foot. An unexpected rise in prices will leave you the poorer because the dollars repaid to you are worth much less than the dollars you lent.
