Q. Consider the following statements:
1.Inflation redistributes wealth from creditors to debtors.
2.Rising inflation indicates rising aggregate demand.
Which of the statements given above is/are correct?

[A] 1 only

[B] 2 only

[C] Both 1 and 2

[D] Neither 1 nor 2

Answer: C

Explanation: There are multi-dimensional effects of inflation on an economy both at the micro and macro levels.

It redistributes income, distorts relative prices, destabilizes employment, tax, saving and investment policies, and finally it may bring in recession and depression in an economy.

A brief and objective overview of the effects of inflation is given below:

  • On Creditors and Debtors: Inflation redistributes wealth from creditors to debtors, i.e., lenders suffer and borrowers benefit out of inflation. The opposite effect takes place when inflation falls (i.e., deflation).
  • On lending: With the rise in inflation, lending institutions feel the pressure of higher lending. Institutions don’t revise the nominal rate of interest as the ‘real cost of borrowing’ (i.e., nominal rate of interest minus inflation) falls by the same percentage with which inflation rises.
  • On Aggregate Demand: Rising inflation indicates rising aggregate demand and indicates comparatively lower supply and higher purchasing capacity among the consumers. Usually, higher inflation suggests the producers to increase their production level as it is generally considered as an indication of higher demand in the economy.

Source: TMH Ramesh Singh