In macroeconomics, what is meant by the term "inflation tax" and who primarily bears it?

• A. It is a one-time fee paid by banks to the central bank when the money supply expands; it is primarily borne by banks through lower profits.
• B. It is the loss of purchasing power from holding money as prices rise; it is primarily borne by people and firms that hold cash and other non-interest-bearing nominal assets.
• C. It is an explicit government tax levied on wage increases to keep real wages constant; it is primarily borne by workers whose nominal wages rise.
• D. It is the increase in real interest rates caused by inflation; it is primarily borne by borrowers because their real debt payments rise.

Answer: (B)

Verified step by step guidance

1. Step 1: Understand the concept of inflation tax. Inflation tax refers to the loss of purchasing power experienced by holders of money when the general price level rises due to inflation.
2. Step 2: Recognize that inflation reduces the real value of money holdings because as prices increase, each unit of currency buys fewer goods and services.
3. Step 3: Identify who bears the inflation tax. It is primarily borne by people and firms holding cash or other nominal assets that do not pay interest or adjust with inflation, as their real wealth diminishes.
4. Step 4: Differentiate inflation tax from other concepts such as explicit taxes, fees paid by banks, or changes in real interest rates, which are distinct economic phenomena.
5. Step 5: Summarize that inflation tax is an implicit cost of inflation, effectively transferring wealth from money holders to the government or other entities that benefit from the increased money supply.