Sample True-False-Uncertain/Explain Test Question and Answer:

T-F-Uncertain, explain in a short essay.  "Inflation benefits debtors."

Uncertain - The answer depends on: 1) whether the debtor has a fixed rate or variable rate loan, and 2) the relationship between actual inflation and expected inflation.  If a borrower has a fixed rate loan, and if the actual rate of inflation is greater than the expected rate of inflation, then a debtor would benefit from inflation.  The debtor would benefit because in the case described above, the real rate of interest would be less than originally expected.

For example, according to the Fisher equation, if a homeowner has a 8% fixed rate mortgage when expected inflation is 3%, the expected real cost of debt would be 5%.  If actual inflation turns out to be 6% instead of 3%, the real interest rate would only be 2% instead of 5%, so the fixed rate borrower would benefit from inflation by having a lower real cost of borrowing than originally expected.

In the case of a variable rate loan a debtor would not necessarily benefit from inflation because the interest would be adjusted in periods of high inflation.  And in the cases where actual inflation is equal to or less than the expected inflation, the debtor would either not benefit, or would actually be hurt by inflation since the actual real interest rate would be higher than expected.

So the answer is uncertain, and depends on the assumptions about the type of debt and the relationship between actual and expected inflation.