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Inflation Tax

| June 2, 2012

What is inflation

Inflation is the rise (only) in the general level of prices of goods and services in the economy over a given period of time. When price levels rise it will cost more to acquire the same amount of goods, or the same quality of service. Inflation leads to a reduction of purchasing power of your money such that the same £50 note would buy less food items in an inflationary environment.
The opposite of inflation is deflation – where we see the costs of goods getting cheaper as time passes.

Inflation Tax

Inflation can have positive and negative effects on the economy. However, the negative factors occur when the rate of inflation is report as being considerably lower than what the economy is really experiencing. This is occurring today in the world where governments have borrowed too much money and need to accumulate funds in order to maintain payments for social programmes such as the state pension, public sector pension, NHS.
The government here in the UK, and around the world have taken a two pronged approach – reducing interest rates to zero and under-reporting the rate of inflation.
Assuming the rate of inflation is reported to be 3%. The banks are offering 1% at best in standard savings accounts. This means that although you invest for a gain of 1%, you are losing 2% annually due to the general rise in cost of goods and services. However, imagine that the real rate of inflation is 8%, but reported as 3% (as we see with fuel prices, certain food items etc). So rather than savers receiving interest aligned with the cost of living they are out by 7%. The money that should have been paid out in interest is the balance saved by the entity you are saving with. This acts as an invisible tax on the saver, taking money that should have been earned. This strategy is mainly affecting those in retirement and those nearing retirement as they tend to have the life savings tied up in fixed income investments – mainly bonds and as I write today the bond rates are extremely low.

Financial repression

The correct term for this means of taxation via careful manipulation of interest rate and efforts to control the entire financial system is known as Financial Repression and it has been use successfully in the past by governments to pay there way out of debt following the World War II.

Financial Repression Article (from Finance and Development Magazine)

Category: Pension Education

About the Author ()

Andrew, founder of the Final Salary website (FS), started the website soon after the government announced drastic changes to pension schemes in 2010 and the need for individuals to take more control of their financial future. As an avid reader of all things finance related, he decided to share his knowledge via this informative website. Andrew brings knowledge across many areas of business, retail and consumer finance.

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