1

The Consumer Price Index in the US in May jumped up by 0.6%. Overall it’s possible that prices on goods (aka inflation) will increase by 10% in 2021. Now, assuming that salaries follow trend as well and increase by 10% nominally, debt will become 10% easier to pay off for a lot of people as the vast majority of consumer debt is not inflation indexed.

So… who’s going to be losing money as a result? Is it the bank? The debt holders, who will lose money in areas other than mortgages? The holders of US government debt? No one?

Improve this question
9
  • 5
    "assuming that salaries follow trend as well and increase by 10% nominally". I heartily challenge that assumption.
    – RonJohn
    Commented Jul 10, 2021 at 15:45
  • 1
    @RonJohn historically salaries follow inflation pretty closely, at least over long periods of time.
    – JonathanReez
    Commented Jul 10, 2021 at 15:59
  • 1
    "over long periods of time." And in the meantime, people lose money.
    – RonJohn
    Commented Jul 10, 2021 at 16:05
  • 1
    @TripeHound let's say you earned $100k/year, with $30k/year being your mortgage payments and $30k/year your other expenses, so 30% goes to mortgage, 30% to other stuff and 40% saved. Now cue inflation, your salary is now $110k/year, your mortgage is still $30k and your expenses are now $33k. This lets you save up $47k/year or 42% of your salary. And that's just 2021, if we see high inflation for a few more years your mortgage will be easier and easier to pay off.
    – JonathanReez
    Commented Jul 10, 2021 at 22:57
  • 1
    @TripleHound it’s actually even better for people with zero savings. Let’s say 50% or your income was spent on servicing debt and 50% on other expenses, with a salary of $100k. With 10% inflation and a 10% salary increase, you would now be spending $105k out of $110k, leaving you with savings for the first time. Though of course inflation hits different sectors of the economy differently so it’s feasible that some groups will lose more than they gain.
    – JonathanReez
    Commented Jul 11, 2021 at 16:34

3 Answers 3

Reset to default
7

In simple terms, it is the lender who "loses money" (or rather loses value) on the loan due to inflation. The reason is that, as you say, most debt is not indexed to inflation. This means it is denominated in nominal dollars, but if inflation occurs the real value of those dollars later (when the debt is paid off) will be less.

Here's a simplified example. Lenny the Lender lends Barry the Borrower $100; the agreement is that Barry will pay back $110 in one year's time. At the time of the loan, hamburgers cost $5, so Lenny has lent enough money to buy 20 hamburgers, and the agreement is set up so that he will get back enough money to buy 22 hamburgers (but the actual agreement is in dollars and does not guarantee any hamburger exchange rate).

Over the next year 10% inflation occurs. Hamburgers now cost $5.50. At the appointed time Barry pays Lenny his $110. This $110 can now only buy 20 hamburgers, just as it did at the outset of the loan period. Thus Lenny has effectively lent the money to Barry for free, since he earned no interest in real dollars.

Obviously I've simplified matters here by assuming that inflation is only affecting the price of a single type of good, namely hamburgers. Also, as mentioned in other answers, whether Barry effectively "loses money" will depend on whether his income rises with inflation. (But as you noted in the question, wages are more likely to rise with inflation than debt payments, and also this loss of value is separate from the loan; the borrower may lose value because their salary goes down in real value, but they're not losing value on the loan itself.) And of course most actual loans have more complex terms than this simple "pay everything plus 10% all at once in one year". Still, this is the basic idea.

The essence of the situation is that a typical loan agreement requires the borrower to pay a certain number of dollars over time; if that number of dollars becomes less valuable, the borrower benefits and the lender loses out, because the purchasing power of the payments is reduced.

Improve this answer
1
  • Of course, the lender could also purchase some hedge against inflation increasing to protect themselves from exactly this situation. In that case, the loss is spread over all hedged lenders (past, present and future) in the form of the cost of hedging against inflation risk. (The same way if my house burns down but I have insurance, the loss is borne by a raise in everyone's fire insurance rates -- past, present and future.)
    – David Schwartz
    Commented Jul 13, 2021 at 15:58
4

People who rely on bond income lose money when prices rise but their income does not. This typically hurts retirees.

And the value of those bonds drops as interest rates (eventually) rise, too.

Improve this answer
1
  • 5
    I would add anyone with significant money sitting in cash or cash-equivalents is a big loser when it comes to inflation.
    – JohnFx ♦
    Commented Jul 12, 2021 at 18:04
1
  • People are "losing money" because they're paying more for goods that they were before
  • Banks are "losing money" because they're earning less money on the loans that are outstanding than they are on new loans.

I use "losing money" in quotes because inflation is more of an opportunity cost than an actual cost. Inflation can be somewhat offset by higher incomes in some cases, and people can adjust their spending habits by buying less expensive goods, by preparing their own meals versus going to a restaurant, etc.

Improve this answer

You must log in to answer this question.

Not the answer you're looking for? Browse other questions tagged .