Q. Consider the following statements: - Inflation benefits the debtors.
- Inflation benefits the bondholders.
Which of the statements given above is/are correct? (UPSC Prelims 2013)
Answer:
1 only
Notes: The correct answer is
[A] 1 only. Inflation has a significant impact on the redistribution of wealth between different economic groups, primarily benefiting those who owe money while eroding the value for those who are owed money.
- Inflation Benefits Debtors (Statement 1 is Correct): When inflation occurs, the purchasing power of money falls. A debtor (borrower) who took a loan before inflation can repay that loan with money that is now "cheaper" or worth less than when they originally borrowed it. In real terms, the value of the debt decreases because the nominal amount remains the same, but the value of the currency used to pay it back has declined.
- Inflation Benefits Bondholders (Statement 2 is Incorrect): Inflation is generally the "enemy" of bondholders. A bond is a fixed-income instrument where the holder receives a fixed interest payment (coupon). When inflation rises, the real value of these fixed interest payments decreases. Furthermore, as inflation increases, market interest rates typically rise, causing the market price of existing bonds to fall. Therefore, bondholders (who are essentially lenders) lose out during inflationary periods.