M & B 4th Edition by Dean Croushore

Exercise 12

An alternative type of mortgage loan is called a price-level-adjusted mortgage (PLAM), which sets all mortgage payments and the principal amount of the mortgage in real rather than nominal terms. Thus, if the infl ation rate was 10 percent in a certain year, the monthly payment would be increased by 10 percent in dollar terms, and the principal value of the mortgage loan also would be increased by 10 percent in dollar terms. Who gains from this type of mortgage: the homeowner or the bank or both? Explain. Who bears the infl ation risk?