Question

Suppose that people expect inflation to equal 3 percent, but in fact, prices rise by 5 percent. Describe how this unexpectedly high inflation rate would help or hurt the following:
a. the government.
b. a homeowner with a fixed-rate mortgage.
c. a union worker in the second year of a labor contract.
d. a college that has invested some of its endowment in government bonds.

Answer 1

Answer:

The answer is:

Helps the government and a homeowner with a fixed-rate mortgage

But hurts a union worker in the second year of a labor contract and a college that has invested some of its endowment in government bonds

Explanation:

The government: This unexpected Increase in inflation help the government in the sense that it reduces the real value of government debts(it erodes the purchasing power of the debtors). It also increases the tax revenue.

A homeowner with a fixed-rate mortgage: This unexpected Increase in inflation also pays this category because the interest rate he is paying for his mortgage is less than the prevailing interest rate.

A union worker in the second year of a labor contract: This unexpected increase hurts this worker because the terms of the contract would have been based on the expected inflation rate(3%) but for this unxpected increase, its purchasing power will be eroded.

A college that has invested some of its endowment in government bonds: It hurts the college because higher inflation rate means the college is receiving a lower interest payment from the bond.