[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

receive in the future will be worth less than the dollars they invested, leaving them
with less than enough to live comfortably in their old age.
When inflation is anticipated, many of its economic costs disappear. Workers
who know that prices will be rising by 5 percent this year, for example, may negotiate
wages that rise fast enough to offset inflation. Firms may be willing to agree to
these larger wage increases since they anticipate being able to raise the prices of
the goods they produce. Lenders know that the dollars they will be repaid will be
worth less than the dollars they lent, so they take this loss in value into account when
setting the interest rate they charge or when deciding whether to make a loan.
But even when inflation is not fully anticipated, workers and investors can immunize
themselves against its effects by having wages and returns indexed to inflation.
For instance, when wages are perfectly indexed, a 1 percent increase in the price
level results in a 1 percent increase in wages, preserving the workers’ purchasing
power. In recent years, both Social Security payments and tax rates have been
indexed. Many countries, including the United Kingdom, Canada, and New Zealand,
sell indexed government bonds so that savers can put aside money knowing that
the returns will not be affected by inflation.
WHO SUFFERS FROM INFLATION?
Although indexing softens the effects of inflation, its protection is far from complete.
So who suffers from inflation today? Many people may suffer a little because
indexing does not fully protect them, but some are more vulnerable than others.
Among the groups most imperfectly protected are lenders, taxpayers, and holders
of currency.
Lenders Since most loans are not fully indexed, increases in inflation mean that
the dollars that lenders receive back from borrowers are worth less than those they
lent out. Many people put a large part of their retirement savings into bonds or other
fixed-income securities. These people will suffer if an inflationary bout reduces the
purchasing power of their savings. The extent to which they will suffer depends in
large measure on whether the price changes were anticipated, as interest rates can
adjust to completely compensate lenders for any inflation that was anticipated.
Taxpayers Our tax system is only partially indexed, and inflation frequently
hurts investors badly through the tax system. All returns to investment are taxed,
including those that do nothing more than offset inflation. Consequently, real aftertax
returns are often negative when inflation is high. Consider a rate of inflation of
10 percent and an asset that yields 12 percent before tax. If the individual has to pay
a 33 percent tax on the return, the after-tax yield to the investor is only 9 percent—
not even enough to compensate for inflation. The after-tax real return in this
example is –1 percent.
Holders of Currency Inflation also makes it expensive for people to hold currency
because as prices rise, the currency loses its value. Since currency facilitates
510 ∂ CHAPTER 23 THE COST OF LIVING AND INFLATION