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Is Inflation Beneficial to Borrowers or Lenders?

Many economists agree that the money supply has an impact on inflation's long-term repercussions. In other words, in the long run, the money supply has a direct and proportional relationship with price levels. As a result, as the amount of cash in circulation rises, so does the price of products and services. Aside from printing additional money, there are a number of other ways to increase the amount of money in circulation.

Interest rates could be lowered, banks' reserve ratios could be reduced (the percentage of deposits held in cash reserves), there could be more confidence in the banking system, or a central bank could buy government or corporate bonds (leaving bondholders with more money to spend), among other things that could increase the money supply. Inflation is defined as a rise in the price of goods and services combined with a decrease in buying power. The purchasing power of a currency is its value stated in terms of the quantity of goods and services that one unit of the currency can buy.

FROM BORROWER’S PERSPECTIVE

If wages rise in line with inflation, and the borrower owing money before the inflation, the borrower gains from the inflation. This is due to the fact that the borrower owes the same amount of money, but they now have more money in their salary to pay down the loan. If the borrower uses the extra money to pay off their debt early, the lender pays less interest. When a company borrows money, the money it receives now will be repaid later with money it earns. Inflation, by definition, causes the value of a currency to depreciate over time. In other words, cash today is more valuable than cash afterwards. As a result of inflation, debtors can repay lenders with money that is worth less than it was when they borrowed it.

FROM LENDER’S PERSPECTIVE

Inflation can aid lenders in a variety of ways, particularly when it comes to granting new credit. For starters, greater prices indicate that more people would seek loans to purchase large-ticket things, especially if their incomes have not increased–this means that lenders will gain new customers. Furthermore, the lender earns extra interest because to the rising pricing of those things.

Second, as prices rise, the cost of living rises as well. People have less money to meet their responsibilities if they spend more money to live (assuming their incomes haven't increased). This is advantageous to lenders since people require more time to repay earlier obligations, allowing the lender to earn interest over a longer period of time. However, if the circumstance results in increased default rates, it could backfire.

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