How Inflation Can Impact Different Income Groups: Understanding Distributional Consequences and Negative Real Interest Rates

Does inflation have distributionary consequences? When is the real interest rate negative?

If inflation rates are high the lender gets back money that can buy back less than the money he lent outReal interest rate = nominal interest rate – inflation (when inflation>nominal interest rate real interest rate is negative)

Yes, inflation can have distributionary consequences. Inflation can affect different groups of people differently, depending on the sources of income and their ability to adjust to changing prices. For example, those who receive fixed income, such as pensioners or workers with fixed-wage contracts, may experience a decline in purchasing power if their income does not keep up with inflation. Similarly, if prices increase more rapidly for essential goods such as food or housing, low-income households that spend a relatively larger share of their income on these goods will be more negatively impacted by inflation than high-income households.

The real interest rate is negative when the nominal interest rate is below the inflation rate. The real interest rate is the nominal interest rate adjusted for changes in prices, such that it reflects the true increase in purchasing power of an investment. If inflation is higher than the nominal interest rate, then the real interest rate will be negative, meaning that the investor’s purchasing power will decline over time. A negative real interest rate is often seen in times of economic recession or unconventional monetary policy, where central banks may reduce nominal interest rates to stimulate economic growth and boost employment by encouraging consumption and investment.

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