The effects of inflation

Suppose Friendly Airlines is considering signing a long-term contract with the union representing its pilots. Friendly Airlines and the union both agree that real wages should increase by 3%. Inflation is expected to be 6%, so they agree on a 9% nominal wage increase.

Now, suppose inflation turns out to be lower than expected, coming in at 5%. This would the union and Friendly Airlines because the real wage increase would now be .

Because of uncertainty about future inflation, the union devotes a large quantity of resources to monitoring inflation indicators in order to maximize its financial position. This illustrates the fact that:

Inflation harms lenders and helps borrowers

Inflation obscures relative price changes

Variable inflation is associated with high transaction co