UPSC Prelims 2013 · Question 16 of 99

UPSC Prelims 2013 question on Inflation Debtors Bondholders

Consider the following statements:

1. Inflation benefits the debtors.
2. Inflation benefits the bond-holders.

Which of the statements given above is/are correct?

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Answer: A. 1 only

Correct Answer: 1 only

According to the official UPSC Answer Key for Prelims 2013, the correct option is 1 only.

Inflation reduces the purchasing power of money. It generally benefits borrowers and hurts lenders or people receiving fixed payments.

1. Inflation benefits the debtors — Correct

Debtors are borrowers who have to repay loans.

During inflation, the real value of money falls, so they repay the loan with money that is worth less than before.

Thus, the real burden of debt decreases.

2. Inflation benefits the bond-holders — Incorrect

Bond-holders are creditors because they lend money and receive fixed interest payments.

During inflation, the real value of fixed interest income and principal repayment falls.

Unless the bond is inflation-indexed, inflation generally hurts bond-holders.

* Inflation redistributes wealth from creditors to debtors.

* Fixed income earners lose during inflation because their income may not rise with prices.

* Savers with fixed-interest deposits may lose in real terms if inflation exceeds interest earned.

* Real interest rate means nominal interest rate minus inflation rate.

* If inflation is higher than the interest rate, the real interest rate becomes negative.

* Inflation-Indexed Bonds protect investors by adjusting returns with inflation.

Inflation benefits debtors by reducing the real burden of repayment, but it hurts bond-holders who receive fixed payments.

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