Consumers generally understand how bad inflation is 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 under certain circumstances, namely if you’re in debt.
The real value of debt decreases when inflation is high. Let’s put it this way: While wages don’t always keep pace with inflation when prices rise rapidly, they tend to rise during these times, and that can make it easier to cover payments on a fixed-rate lending product like a mortgage or a student loan. The idea is that you now earn more, but your old debt obligations remain unchanged.
Only a fraction of consumers understand that inflation can benefit debtors in this way, according to a research paper by financial experts at Goethe University in Frankfurt and the University of Chicago Booth School of Business. And for better or worse, when people are educated about this effect, they respond by spending money and borrowing more freely, according to the study.
Inflation and debt: what research has found
The researchers teamed up 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 seventy years.
At the start of the study, only about a third of participants understood that inflation reduces the real value of fixed-rate debt. For comparison, 75% of participants understood that inflation has a negative impact on the value of savings in fixed rate accounts.
Participants were divided into groups, one of which was given information about how inflation erodes the real value of debt.
When consumers were informed about debt erosion, they subsequently spent more money and showed “reduction in debt aversion” in a hypothetical home loan scenario.
Because matter
According to the paper, consumers have more positive views about their debt and wealth when they are informed about the effects of high inflation on debt. These perceptions tend to lead to increased spending.
“Households generally dislike high inflation,” the researchers wrote. “However, some households could 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 consumers into further debt as high prices of everyday goods strain budgets. Additionally, debt can grow quickly considering that consumers typically see higher interest rates for credit cards and new loans when inflation is higher.
More from Money:
12 Best Debt Consolidation Loans of April 2024
Young adults are trying to ‘hack’ their way to financial stability
Americans have never been so behind on their credit card bills