Unexpected Inflation
Unexpected Inflation and Redistribution of Wealth in Canada
Césaire A. Meh, Canadian Economic Analysis, and Yaz Terajima, Financial Stability
One of the most important arguments in favour of price stability is that unexpected inflation generates changes in the distribution of income and wealth among different economic agents. These redistributions occur because many loans in the economy are specified in fixed-dollar terms. Unexpected inflation redistributes wealth from creditors to debtors by reducing the real value of nominal assets and liabilities. This article quantifies the redistributional effects of unexpected inflation in Canada. To this end, we first provide comprehensive evidence of the nominal assets and liabilities of various economic sectors and household groups. We find that the redistributional effects of unexpected inflation are large even for episodes of low inflation. The main winners are young, middleincome households, who are major holders of fixed-rate mortgage debt, and the government, since inflation reduces the real burden of their debt for both groups. The losers are high-income households and middle-aged, middle-income households that hold long-term bonds and nonindexed pension wealth.
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here is ongoing research on potential refinements to monetary policy regimes in countries with low and stable inflation. In Canada, for example, a systematic review of the current inflationtargeting framework is underway (see the other articles in this issue). An issue that has received relatively less attention is the redistributional effects of unexpected inflation.1 Redistributional effects occur because many savings, investments, and loans in the economy are specified in money terms (i.e., not adjusted for inflation); unexpected inflation therefore redistributes wealth from lenders to borrowers by lowering the real value of nominal assets and liabilities.2 The analysis of these effects may be important since the welfare costs of inflation depend not only on
Césaire A. Meh, Canadian Economic Analysis, and Yaz Terajima, Financial Stability
One of the most important arguments in favour of price stability is that unexpected inflation generates changes in the distribution of income and wealth among different economic agents. These redistributions occur because many loans in the economy are specified in fixed-dollar terms. Unexpected inflation redistributes wealth from creditors to debtors by reducing the real value of nominal assets and liabilities. This article quantifies the redistributional effects of unexpected inflation in Canada. To this end, we first provide comprehensive evidence of the nominal assets and liabilities of various economic sectors and household groups. We find that the redistributional effects of unexpected inflation are large even for episodes of low inflation. The main winners are young, middleincome households, who are major holders of fixed-rate mortgage debt, and the government, since inflation reduces the real burden of their debt for both groups. The losers are high-income households and middle-aged, middle-income households that hold long-term bonds and nonindexed pension wealth.
T
here is ongoing research on potential refinements to monetary policy regimes in countries with low and stable inflation. In Canada, for example, a systematic review of the current inflationtargeting framework is underway (see the other articles in this issue). An issue that has received relatively less attention is the redistributional effects of unexpected inflation.1 Redistributional effects occur because many savings, investments, and loans in the economy are specified in money terms (i.e., not adjusted for inflation); unexpected inflation therefore redistributes wealth from lenders to borrowers by lowering the real value of nominal assets and liabilities.2 The analysis of these effects may be important since the welfare costs of inflation depend not only on
Cited: Crawford, A., C. A. Meh, and Y. Terajima. 2009. “Price-Level Uncertainty, Price-Level Targeting, and Nominal Debt Contracts.” Bank of Canada Review, (Spring): 31-41. Doepke, M. and M. Schneider. 2006. “Inflation and the Redistribution of Nominal Wealth.” Journal of Political Economy 114 (6): 1069–97. Meh, C. A., J.-V. Ríos-Rull, and Y. Terajima. 2008. “Aggregate and Welfare Effects of Redistribution of Wealth under Inflation and Price-Level Targeting.” Bank of Canada Working Paper No. 2008-31. Meh, C. A. and Y. Terajima. 2008. “Inflation, Nominal Portfolios, and Wealth Redistribution in Canada.” Bank of Canada Working Paper No. 2008-19. 50 UNEXPECTED INFLATION AND REDISTRIBUTION OF WEALTH IN CANADA BANK OF CANADA REVIEW SPRING 2009