Inflation

Introductory textbooks tell you that inflation is costly because it distorts price signals and leads to an undesirable redistribution from the private sector to the government. The governments get the income from the newly printed money – the seigniorage – plus the income from the fiscal drag. Whereas no one disputes the distributive consequences of inflation, the interpretation has suddenly changed after financial crisis and the ballooning government debts: Leading economists now declare that plundering the private sector income is a good thing because governments are in danger to go broke and desperately need more income.

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Fiscal drag


Fiscal drag is a way for the government to make money through inflation. How? If your income goes up because of inflation, you end up in higher income tax brackets even if your real income remains constant – something often described as “bracket creep”. A similar effect operates on savings. An increase in the inflation rate reduces what’s left of the after-tax interest payments.

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