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Stive Nkomo
(, )
Suppose that a country's inflation rate increases sharply. What happens to the inflation tax on the holders of money? Why is wealth that is held in savings accounts not subject to a change in the inflation tax? Can you think of any way holders of savings accounts are hurt by the increase in the inflation rate?
ALL ANSWERS
Prof Garcia
(University of the Witwatersrand, johannesburg, Gauteng)
Inflation:
Inflation is defined as the rapid increase in the prices of the basic services and products experienced in a given economy. The increased prices lower the consumers' purchasing power. When there is high inflation, the nominal interest rates are increased since people have more money to spend. Besides, inflation can be reduced by regulating the money supply to ensure it does not exceed its demand.

Answer and Explanation:
1. When a nation's inflation rate rises sharply, the inflation tax on the money holders rises significantly since the money has significantly lost value. The inflation tax is defined as an economic cost incurred by the cash holders and the cash equivalents in a currency denomination as a result of inflation effects.

2. The wealth held in the savings account is not subjected to any change in the inflation tax since the nominal interest rates will rise as the inflation increases.

3. An inflation rate increase hurts the savings account holders since they are taxed on their nominal interest income; hence their returns fall due to higher inflation.