Unexpected Inflation

If the rate of inflation from one year to the next differs from what economists and consumers expected, then unexpected inflation is said to have occurred. Unlike expected inflation, unexpected inflation can have serious consequences for consumers ranging well beyond inconvenience. The major effect of unexpected inflation is a redistribution of wealth either from lenders to borrowers, or vice versa. In order to understand how this works, it is important to remember that inflation reduces the real value of a dollar (the dollar will not buy as much as it once did). Thus, if a bank lends money to a consumer to purchase a home, and unexpected inflation is high, the money paid back to the bank by the consumer will have less purchasing power or real value than it did when it was originally borrowed because of the effects of inflation. If a bank lends money and inflation turns out to be lower than expected, then the shoe is on the other foot and the lender gains wealth, since the money paid back at interest is of more value than the borrower expected. In volatile circumstances, when inflation seems to be moving unexpectedly, neither lenders nor borrowers will want to risk the chance of hurting themselves financially, and this hesitancy to enter the market will hurt the entire economy.