(a) - Borrowers will be in winning situation but lenders will be loosing part of profits because bigger part of nominal interest rate will be consumed by inflation. Conversely, deflation will result in lower interest rates as the demand for money drops. D)hurting lenders by reducing the value of their loans and lowering the interest rate on loan. Demand for goods decreases since consumers delay purchases, expecting lower prices in the future. When deflation occurs or is expected to occur, lenders will generally dial back interest rates. The decline in prices wasn't enough to spur demand because rising unemployment undercut consumer purchasing power to a far greater degree. Deflation A) hurts borrowers and savers. That can be positive. How Does Deflation Affect Borrowers And Lenders? One of the biggest problems with it is that it effectively increases the cost of your debts. The offers that appear in this table are from partnerships from which Investopedia receives compensation. Unexpected inflation benefits borrowers but does not affect lenders. B) helps borrowers and hurts lenders. Since debtors usually pay back loans in a nominal amount, they want to give up the least purchasing power possible. Even if the interest rate on your debt goes down, the effective cost of the debt goes up. Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. When someone lends you money, he assumes that you'll be paying him back in the future with money that's worth less than today. (Learn more in our Economics Basics Tutorial. C) unlike inflation, affects neither borrowers nor lenders. You could spend the $1,000 to pay your mortgage, or you could buy 300 gallons of gas with it. Bank lending drops since borrowing money makes less sense in regards to the real cost. Lenders benefit, but because they are more likely to save than borrowers, demand is sapped overall. Deflation has an even bigger risk. If you lose your job, you could end up unable to pay off your debt at all. Yet prices have consistently dropped as the technology improved and spurred more demand. Federal Reserve Chairman Ben Bernanke has adopted a policy of "quantitative easing," which essentially amounts to printing money to buy U. S. Treasuries. That's why he charges you interest. That's a rare thing, which is why deflation is a rare thing. This reduction in economic activity can cause a recession or a depression. Bankrate.com: Afraid of Deflation? Steady-State Costs of Deflation. If you have debts at variable interest rates, you might benefit a little bit from deflation. If lenders know that they'll be paid back with money more valuable than the money they lend, they can charge less interest and end up better off. Aggregate demand is the total amount of goods and services demanded in the economy at a given overall price level at a given time. Deflation reduces aggregate demand, deepening an economic slump which may lead to further deflation Since the dollar buys more in deflationary times but your debt payment stays the same, you're actually paying more. Reflation is a form of policy enacted after a period of economic slowdown. If people buy fewer products, companies need fewer people to make them. When prices drop on everything, consumers and businesses start to pull back on spending, waiting for even lower prices. Both Borrowers And Lenders Are Negatively Impacted. Inflation dynamically affects lending institutions along a fairly predictable course from the cycle’s early stages to its well-advanced evolution. Once this vicious cycle took hold, it lasted a decade until the beginning of World War II.
Possible EffectsThere are many reasons to be concerned about a prolonged deflationary period, even without an event as devastating as the Great Depression:1. Deflation helps the lender because when deflation occurs, the lender receives a higher... See full answer below. Learn more in The Upside Of Deflation. occurs when borrowers reduce their aggregate spending, because the deflation increases the debt burden that borrowers experience. Few living Americans know what it's like to face the opposite phenomenon - deflation.TUTORIAL: Economic Indicators To KnowSince too much inflation is generally regarded as a bad thing, wouldn't it follow that deflation might be good thing? Menu costs. Policies include But as long as businesses and people feel less wealthy, they spend less, reducing demand further. Deflation has one short-term benefit: It can decrease interest rates. … In that case, the goal is to spur buyer demand to stimulate the economy.The Great DepressionSevere economic contraction during the Great Depression resulted in deflation averaging -10.2% in 1932. Unemployment rises and wages decline as demand drops and companies struggle to make a profit. Borrowers Are Negatively Impacted And Lenders Are Positively Impacted. It's nice when prices drop. Deflation: A) hurts borrowers and helps lenders. This is because the loan would be paid back with money that is worth more than it is now.4. While this might sound like a good thing, it really isn't. Deflation, like inflation, can create winners and losers in an economy. Inflation can benefit either the lender or the borrower, depending on the circumstances. )What Is It?Deflation is a general decline in prices as a function of supply and demand for products, and the money used to buy them. 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