The Surprising Way Inflation Can Be Good for People With Debt
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Consumers generally understand how inflation is bad for them: Everything costs more, and cash and savings lose value. But most people aren't aware that inflation can actually be a good thing in certain circumstances — namely, if you’re in debt.
The real value of debt decreases when inflation is high. Think of it this way: While wages don’t always keep up with inflation when prices are rising rapidly, they do tend to increase during these periods, and that can make it easier to cover the payments on a fixed-rate loan product such as a mortgage or student loan. The idea is that you're now earning more, but your old debt obligations are unchanged.
Only a fraction of consumers understand that inflation can benefit debtors in this way, according to a research paper from finance experts at Goethe University Frankfurt and the University of Chicago Booth School of Business. And for better or worse, when people are educated on this effect, they respond by spending money and borrowing more freely, according to the paper.
Inflation and debt: what the research found
The researchers partnered with an unnamed German bank to conduct a study involving 3,000 of its customers. The study began in July 2022, when the inflation rate in Germany was 8.7% — the highest level for the country in seven decades.
At the start of the study, only about a third of the participants understood that inflation reduces the real value of fixed-rate debt. For comparison, 75% of the participants understood that inflation negatively impacts the value of savings in fixed-rate accounts.
The participants were split into groups, one of which was given information about how inflation erodes the real value of debt.
When consumers were educated about debt erosion, they subsequently spent more money and showed a “reduction in debt aversion” in a hypothetical real estate loan scenario.
Why it matters
Consumers have more positive views about their debt and their wealth when they're taught about the effects of high inflation on debt, according to the paper. These perceptions tend to lead to increased spending.
“Households typically dislike high inflation,” the researchers wrote. “However, some households might benefit from unexpected inflation: it erodes the real value of debt with fixed nominal interest obligations, redistributing wealth from nominal savers to borrowers.”
Keep in mind, however, that inflation can also lead to consumers going deeper into debt as high prices for everyday goods strain budgets. Additionally, debt can snowball faster considering that consumers usually see higher interest rates for credit cards and new loans when inflation is higher.
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