Consider the following statements:
- Inflation benefits the debtors.
- Inflation benefits the bond-holders.
Which of the statements given above is/are correct?
- 1 only
- 2 only
- Both 1 and 2
- Neither 1 nor 2
Explanation
Statement 1 is correct
- When inflation rises, the value of money decreases over time. For a debtor (someone who owes money), this means the real value of the amount they need to repay diminishes.
- Example:
- X borrowed ₹1,00,000 at a fixed interest rate of 5% per year.
- If inflation rises to 10%, X repays the loan with money that has less purchasing power, effectively reducing the real burden of his debt. Thus, inflation benefits him.
- Lenders lose as price rise erodes the purchasing power of the money they are repaid, thus discouraging lending.
Statement 2 is incorrect
- Bondholders receive fixed interest payments. With inflation, the purchasing power of these payments decreases, meaning bondholders lose value in real terms.
- Example:
- X holds a bond that pays ₹10,000 annually as interest. With inflation rising from 2% to 8%, the ₹10,000 X receives can now buy fewer goods and services. This means X loses value in real terms.
