“Inflation is taxation without legislation.”

Inflation reduces the value of money held by the public, similar to a tax. The impact of inflation on purchasing power acts as a hidden cost on consumers’ wealth.

Inflation functions like a tax because it diminishes the real value of money. When prices rise, the same amount of currency buys less, effectively reducing people’s wealth if their income doesn’t increase at the same rate. This erosion of purchasing power affects everyone who holds money, making it a universal ‘tax’.

However, unlike traditional taxes imposed by governments, which are debated and legislated, inflation can occur without any direct legislative action. It’s often the result of complex economic factors, including monetary policy decisions by central banks, supply and demand dynamics, and changes in production costs.

Purchasing power risk, also known as inflation risk, refers to the potential decrease in the value of money over time due to inflation. When inflation occurs, the general price level of goods and services rises, meaning that each currency unit can buy fewer items than before. This risk is particularly relevant for investors holding cash or fixed-income securities, as the real return on their investments may be reduced when inflation is high.

In simpler terms, if you have a certain amount of money today, you might be able to buy a basket of goods with it. However, if prices increase over time due to inflation, that same amount of money will buy you a smaller basket of goods in the future. This erosion of purchasing power can affect not only personal finances but also investment returns and overall economic health.

Central banks often adjust interest rates to try to control inflation and maintain the currency’s purchasing power. One common measure of purchasing power in the U.S. is the Consumer Price Index (CPI), which tracks the average price change over time for a basket of goods and services, including transportation, food, and medical care3. Monitoring CPI and other economic indicators can help individuals and policymakers understand and mitigate the impact of purchasing power risk.

Source:  https://haikhuu.com/education/purchasing-power-risk