Suppose that a country's inflation rate increases sharply. As a result, the inflation tax on holders of money. True or False: Wealth in savings accounts is not subject to a change in the inflation tax because the nominal interest rate will increase with the rise in inflation. True False

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Javon Shea

6 January, 16:33

Suppose that a country's inflation rate increases sharply. As a result, the inflation tax on holders of money. True or False: Wealth in savings accounts is not subject to a change in the inflation tax because the nominal interest rate will increase with the rise in inflation. True False

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Answers (1)

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Leandro Villa · Answer 1

A) True

B) False

Explanation:

If a country's inflation rate increases sharply, the inflation tax the loss in wealth suffered by holders of money as a result of inflation will definitely rise significantly.

Since money is neutral in the long run, inflation should not affect the real interest rate (over the long run) but only the nominal interest rate, which, in accordance with the Fisher effect should adjust one for one with the price level. Thus, wealth in savings accounts is not affected by changes in the inflation tax. However, holders of savings account are hurt by the increase in the inflation rate because they are taxed on their nominal interest income, so their real returns falls as a result of higher inflation.