Consider the following statements: 1. Inflation benefits the debtors. 2. Inflation benefits the bond-holders. Which of the statements given above is/are correct?

Inflation redistributes wealth from creditors to debtors by reducing the real value of nominal assets and liabilities [1]. Statement 1 is correct because inflation allows borrowers (debtors) to repay their loans with money that has lower purchasing power than when it was originally borrowed [1]. Statement 2 is incorrect because bond-holders are essentially lenders (creditors) who receive fixed nominal returns. As inflation rises, the real value of these fixed interest payments and the principal amount at maturity declines, leading to a loss for the bond-holder [1]. While inflation-indexed bonds exist to mitigate this, standard bond-holders are negatively impacted as inflation erodes the real interest rate and the purchasing power of their future cash flows. Therefore, inflation benefits debtors but disadvantages bond-holders.

Sources

1. [1] Indian Economy, Nitin Singhania .(ed 2nd 2021-22) > Chapter 4: Inflation > EFFECTS/IMPACT OF INFLATION > p. 70