Inflation's Impact: Purchasing Power, Interest Rates, and Long-Term Agreements

Understanding the Impact of Inflation

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Question

Inflation is problematic for which of the following reasons

I. Purchasing power declines at a faster rate than incomes rise

II. Inflation causes nominal interest rates to rise

III. Inflation creates a disincentive to enter into otherwise beneficial long-term agreements

Answers

Explanations

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A. B. C. D. E. F.

Explanation

Inflation generally implies that all prices, including the price of labor, increase at the same rate.

Therefore inflation does not cause a real decline in income. Although nominal interest rates would rise with increased inflation, this does not cause a fundamental economic problem. However, because inflation tends to create long-term uncertainty, many long-term agreements are foregone that would otherwise be beneficial.

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