Consider an economy with an annual inflation rate of 4%. Cash pays a 0% nominal interest rate while government bonds pay a 6% nominal interest rate.
Two types of households have the following portfolios:
Poor households: 80% of their financial wealth is in cash and 20% in bonds.
Rich households: 20% of their financial wealth is in cash and 80% in bonds.
Which statement is correct? (For your answer, assume that expected inflation is equal to actual inflation)

Question

Consider an economy with an annual inflation rate of 4%. Cash pays a 0% nominal interest rate while government bonds pay a 6% nominal interest rate. 
 Two types of households have the following portfolios: 
 Poor households:  80% of their financial wealth is in cash and 20% in bonds. 
 Rich households:  20% of their financial wealth is in cash and 80% in bonds. 
 Which statement is correct? (For your answer, assume that expected inflation is equal to actual inflation)

Answer

Poor households earn a higher average real return than rich households, because holding cash is safer and protects them from inflation risk.

Answer

The real return on cash and bonds is identical under no arbitrage (approximately −4%), so inflation reduces the real wealth of poor and rich households by the same percentage.

Answer

Both groups earn an average real return of about +2%, so inflation does not create inequality through differences in portfolios.

Answer

Poor households earn an average real return of about −3%, while rich households earn about +1%, so inflation increases inequality through financial investment.

Crowdly

Consider an economy with an annual inflation rate of 4%. Cash pays a 0% nominal ...

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