Answer to Question #222404 in Macroeconomics for jyoti

Question

what do you understand by inflation tax? who pays inflation tax?

Answer 1

Solution:

Inflation tax refers to the penalty for holding cash during a time of high inflation. This arises when the government raises revenue by printing more money or reducing interest rates flooding the market with cash, which ultimately raises inflation. As a result, the purchasing power of households holding cash declines since cash becomes less valuable due to inflation.

 

The inflation tax is paid by the holders of cash and highly liquid assets. Households who hold cash and other highly liquid assets tend to see their holdings shrink in value in the long run due to inflation effects. This also includes households who keep their money in a savings account as they will not be able to save as much due to high inflation.