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8 May, 2015 - 11:18

If inflation is fully anticipated, the redistribution effect of inflation is nonexistent. This can be accomplished with cost of living adjustments for income to offset the loss of purchasing power, and by indexing nominal interest rates (i.e. increasing the nominal interest by the rate of inflation). The drawback of using various schemes of anticipated inflation is that it perpetuates inflation.

In the 1980's, variable interest rates for mortgages became increasingly popular. Both borrowers, i.e. home buyers, and lenders, i.e. banks, can benefit from the arrangement. With interest tied (or indexed) to inflation, home buyers see their payments reduced if inflation slows down. But, banks are also protected from the loss of purchasing power of the repayments should inflation speed up.