1. 12.4: Effects of Inflation 1. Decreasing value of the dollar
The dollar can buy less and less products as prices rise
Hurts people on a fixed income (retirees) ↓
2. Decreasing real return on investments
Real return – not the dollars that are returned from investments, but the value of the dollars that are returned

2. Effects of High Inflation on Investment
Assume:
Inflation rate = 10%
Interest rate = 5%
$100 invested on Jan 1. and returned on Dec. 31
Date Transaction Value of Investor’s Borrower’s
Transaction Real Return Real Return

3. Inflation rate = interest rate Inflation rate < interest rate
Investors make 0 real return
Inflation rate < interest rate
Investors + real return
Borrowers − real return
Inflation rate > interest rate
Investors − real return
Borrowers + real return

4. 3. Increasing interest rates
Investors/lenders/creditors will charge higher interest rates during high inflation to make up for their declining real return
This will in turn hurt borrowers

5. Summary
Anyone on a fixed income (retirees, investors) are hurt by inflation
Anyone with fixed expenses (borrowers) is helped by inflation
Anyone with fixed income (lenders, retired) is hurt by inflation
Eventually, interest rates will rise to compensate for this