mock exam 3 morning session Q35 : L Fine said : if the central bank is able to credibly announce that they will maintain the money supply growth rate so increased inflation rate is well anticipated , borrowers lenders workers and employers will incorporate the new higher rate of inflation into long-term contract , so there will be no adverse impact on economy " the answer said the statement is right . why ??
If inflation is higher than expected at the time of the contract signing the employee loses out. For example, if the employee gets 50K with 4% increases each year but inflation runs at 5% then they are not really getting raises in real terms. In this case the employer wins. The opposite would be true if inflation was less than expected. So the inflation EXPECTATIONS are used for long-term planning. Deviations from the expectations will cause one party to profit at the expense of another (zero sum game). Good luck on the exam!
thanks !
yeah…unexpected inflation is what hurts
That’s the theory for CFA exams, at least. I’m expecting inflation down the road and I expect it to hurt. However, if you expect inflation, you factor that into your investment decisionmaking. When everyone does that, what emerges is that investments will require premiums to compensate for expected levels inflation (usually that happens by assets by falling in value and therefore generating higher subsequent returns or yields). Falling in value is the response to unexpected changes in expectations. As long as things are expected, then the present values/returns already reflect the need for the inflation premium.
"so there will be no adverse impact on economy " But what about transaction costs and tax effects? (See Secret Sauce Page 63). “Even when inflation rates are correctly anticpated, it has adverse effects:”…
and the effects of lower investment returns which Schweser specifically mentions. Dumb question.
There’s a third mock exam?