Inflation Tax is the metaphorical representation of economic disadvantage which the bearers of cash or its equivalent undergo in a single currency denomination. In case of Inflation Tax, such disadvantages appear owing to the impact of inflation, which function as a hidden tax and subtract value from those assets.
Nature of Inflation Tax:
An Inflation Tax does not always involve debt elimination. Simply by eliminating cash or currency, the government of a country hastens liquidity, which may initiate pressures arising out of inflation. Under the influence of inflationary pressures, the taxes applicable on consumer income and expense extracts the additional cash from the country's inhabitants.
Effects exerted by Inflation Tax:
Sometimes, Inflation tax affects the economy of a country negatively, when it puts into distress, the middle-class population of a country, having low income. The government of a country raises the monetary amount available with its economy, by printing bills and paper notes. This, in turn, generates and increases revenues, initiating a change in the real money balance. All these activities brings about inflation in the economy of a country. The effects of raising the supply of money make the money-holders to pay the Inflation Tax, as the most evident cost of inflation.
One more impact exerted by Inflation tax is that the inflation-indexed bonds are also associated with the risk arising out of inflation This is because inflation compensation is subject to payment of tax.
Tax on the Inflation Tax:
A common effect of Inflation Tax is that it levies tax on both investment “income” and interest, against the nominal gains or the nominal interest rate. This meas that if a person purchases a bond with a interest rate of 6% and inflation rate worth 4%, he/she will receive the “Real” interest at the rate of 2%. Whatever be the case, this “Tax on the Inflation Tax” is equivalent to a tax on holdings (wealth tax). This tax is equivalent to the nominal tax rate .
EM currencies stabilized after the FOMC meeting last week. Yet the Fed clearly signaled that it remains on track to start hiking rates around mid-2015. While Yellen’s guidance was taken as dovish (tightening won’t be at a predictable, “measured” pace), we still feel the looming Fed tightening cycle remains negative for EM. Furthermore, commodity prices remain soft. This and the upcoming turn in the US interest rate cycle should maintain downward pressure on EM currencies through H1 2015.
Andrea Edwards has worked in marketing and communications all over the globe for 20 years, and is now focused on her passion – writing. A gifted communicator, strategist, writer and avid blogger, Andrea is Managing Director of SAJE, a digital communications agency, and The Writers Shop – a regional collaboration between the best business writers in Asia Pacific
James W. Harpel Professor of Capital Formation and Growth at the John F. Kennedy School of Government in Harvard University. Director of Program in International Finance and Macroeconomics at the National Bureau of Economic Research.