The inflation tax refers to:

• A. a tax imposed by the government on goods and services to control inflation
• B. the reduction in the real value of money held by the public due to rising prices
• C. the increase in income tax rates during periods of inflation
• D. a tax paid by banks on the amount of money they lend during inflationary periods

Answer: (B)

Verified step by step guidance

1. Understand the concept of inflation tax: it is not a formal tax imposed by the government, but rather an implicit cost borne by holders of money when inflation erodes the purchasing power of their cash balances.
2. Recognize that inflation causes prices to rise, which means the real value (or purchasing power) of money decreases over time.
3. Identify that the 'inflation tax' refers to this reduction in the real value of money held by the public, effectively acting like a tax because it reduces wealth without a direct government levy.
4. Distinguish this from other options such as explicit taxes on goods and services, income tax rate changes, or taxes on bank lending, which are not what economists mean by 'inflation tax'.
5. Conclude that the correct understanding of inflation tax is the loss in real value of money due to rising prices, which reduces the real wealth of money holders.