Why are creditors harmed by unexpected inflation?
A)Creditors receive lower nominal rates of interest when prices rise.
B)Creditors are paid back with more valuable dollars.
C)Creditors receive higher nominal rates of interest when prices rise.
D)Creditors are paid back money with less spending power than they expected when the money was loaned out.

Question

Why are creditors harmed by unexpected inflation?
A)​Creditors receive lower nominal rates of interest when prices rise.
B)​Creditors are paid back with more valuable dollars.
C)​Creditors receive higher nominal rates of interest when prices rise.
D)​Creditors are paid back money with less spending power than they expected when the money was loaned out.

Quizplus · Accepted Answer

Creditors are harmed by unexpected inflation because they are paid back the same amount of money in nominal terms, but the money they receive has less purchasing power than they originally lent out. This means that the real value of their loan has decreased, reducing their overall returns. For example, if a creditor lent out $100 at a 5% interest rate, expecting to receive $105 in a year's time, but unexpected inflation means the value of the dollar has gone down by 5%, then they will still receive $105, but the real value of that money is only $99.50 due to the inflation, causing them to lose out.

Why Are Creditors Harmed by Unexpected Inflation