Nope, deflation hurts people who owe money by increasing the value of the debt they owe. Under deflation, nominal wages go down, and since debt (especially the principle) is nominal, that means the debt-income ratio rises, making the debt harder to pay off.
But the banks know there will be inflation, and therefore they can price that in at the moment the contract is signed, raising the nominal rate to counterbalance inflation, no?
Under normal circumstances - I don't think Banks directly price for inflation unless it's a financial instrument specifically linked to a certain measure of inflation.
I worked in a bank for a few years - doing credit risk in both consumer (cards, personal loans, etc) and investment banking (bonds). When it comes to consumer loans, like cards, mortgages, personal, etc, the basic formula is the cost of funds plus a margin that reflects the risk (i.e. card loans more risky than mortgages).
Cost of funds relates to how much it costs for the bank to obtain those funds - its an aggregate of various wholesale market rates, the composition of its deposit base, and a bunch of other things.
Inflation risk is something I never had to factor - but it could have just been because I wasn't working in a time with a major inflationary shock
Actually it's related to a theoretical "zero-risk" investment. Mortgages come with some risk, therefore they need to be priced above the returns for a zero-risk investment. In an inflationary economy, the theoretical "zero-risk" investment is typically something better than just holding the cash, but it can be smaller than inflation (meaning there is no way to gain money without accepting some amount of risk), or it can be larger than inflation. It has varied over time in a way that does not match up with inflation, which disproves your statement.
Side note:
In a deflationary economy, then "zero-risk" would be just holding on to the cash. Of course, that's still not risk-free since you might have been wrong about the economy being deflationary.
I genuinely can't tell if you understand what I said or not. (It isn't my finest work, but if you read my reply in the context of the post to which I was replying, it will make more sense.)
I'm well aware that there's a risk-spread over the base rate for mortgages. My point was that the GP said he worked in a bank pricing credit and never had to figure anything to do with inflation; he only had to deal with a cost of funds figure and therefore banks don't price inflation into credit products.
My point was that cost of funds figure WAS the inflation figure.
Now, if you're arguing that there isn't 100.000% correlation between the various cost of funds rates and the various measures of inflation, I'll agree, but posit that the correlation is high, just not perfect.
I think the correlation is very weak. We've had very high cost of funds in times of low-inflation. All the bankers care about is if they can make more money lending it out as a mortgage than they can putting it somewhere else (after factoring in risk). If there is no low-risk inflation hedge, then they could very well lend out money at rates below inflation (after factoring in their risks), since that could still be a higher return than any available lower-risk investment.
