Consider the following statements Assertion A Inflation redistributes wealth from creditors to debto...........

Economic Affairs Inflation

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Consider the following statements.

Assertion (A): Inflation redistributes wealth from creditors to debtors.

Reason (R): Higher inflation lowers the effective cost of credit for the debtor.

In the context of the above, which of these is correct?

A is correct, and R is an appropriate explanation of A

A is correct, but R is not an appropriate explanation of A.

A is correct, but R is incorrect

Both A and R are incorrect.

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Explanation:

Suppose a bank lent you Rs. 1 lakh at 10% p.a. interest rate. When the inflation rate is 6%, the bank is getting a net interest rate of 4% (ten minus six). This net interest rate is the bank’s profit margin from lending this sum of money. When inflation increases, to say 8%, bank’s net earning reduces as net interest rate (or real interest rate) has come down to 2%. This benefits the debtor because the real value of Rs. 1 Lakh has reduced due to inflation, and in effect he is paying less than what he borrowed.