Assuming that the government underreports inflation rate, how does it affect someone with both a stagnant wage and a large fixed debt (e.g. mortgage)?
(i have a general idea, but i’d like some outside feedback)
Inflation reduces the purchasing power of your money.
Food, rent and clothing prices etc. have all increased but their wages have not increased. If you have a job that does not increase its wages in relation to inflation the employee will have to do more with less.
This is a great situation for bonds (which is why most central banks have been letting inflation get out of hand).
If you owe money you like inflation because when you pay back the bond, you will be able to use your inflated money to payback a loan.
If you lived in a place like Zimbabwe with hyperinflation. If you owed 100 Zimbabwe Dollars today and made 10,000 Zimbabwe Dollars, and when the bond was due you salary increased to 100,000 Zimbabwe Dollars. You still only owe 100 Zimbabwe Dollars - assuming the bond has not adjusted for inflation.
However if you own the bondholder, you would not be very happy as you should have invested in a financial instrument that would have increased at the same rate as inflation - known as capital preservation.
So to answer the OPs question then, if you’re locked into a fixed rate mortgage and inflation occurs but your salary is not adjusted, the impact on you depends on a deeper analysis of what you’re asking.
If your salary is not adjusted everything else is more expensive but your interest rate on your loan is locked in. In terms of the loan, good for you inflation isn’t screwing you in that way, but you’re still screwed because pre inflation 20% of your monthly income went to your mortgage while 60% of your monthly income went to everything else, and now to maintain the same standard of living 20% of your monthly income still goes to your mortgage but now 65% of your monthly income goes to everything else.
So it can be answered two ways.
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You’re in great shape in terms of not getting screwed on your fixed rate for the home. The lender is screwed because the dollars you are paying back are worth less.
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You’re in rough shape generally speaking, not in terms of the inflation impact on your mortgage, but you have this large fixed obligation hanging over your head while everything else is getting more expensive. However, I think #1 answers the question you were asking.
Hands down, you’re better off than adjustable rate.
ok, that is what i thought too.
it depends on the mortgage loan terms. could be a 5/25, and the Fed already said it’s keeping rates unchanged till end of 2014 and most likely incrementally and minimally increase in over a long period of time.
there was another aspect of this question that i wanted to touch upon:
If the government underreports the inflation rate, it just translates into an artificially lower borrowing rate if the person chooses to take out more fixed debt (b/c nominal = real + inflation). well, in this current stagflation economy…
do you really trust the fed at their word?
Actually, I’d probably trust the Fed at their word more than pretty much any other part of the US Government.
agree, but thats not saying much