Nov 162017
 

Why Do Governments Target 2% Inflation?

The Bank of Canada maintains an inflation rate target of 2%. The official websites of Central Banks in the U.S., in Europe, and in Japan all appear to target this magical number when deciding how to conduct their monetary policies. But why? Inflation isn’t necessarily a good thing. There are ways to grow the economy and generate prosperity without increasing the cost of goods and services. But inflation does provide the government with two major advantages!

Governments tend to target 2% inflation rate

1. Taxation by Inflation

In the book, The Greatest Con, author Irwin Schiff explains that, “inflation is the government’s silent partner,” because it allows the government to earn more tax revenue, without officially increasing tax rates. For example, a mechanic who made $40,000/yr in the 1980s could be making $80,000/yr doing the same work today due to inflation. If his cost of living also doubled then this looks fine on the surface. However, an $80,000 income is subject to a higher tax bracket than $40,000. Since his marginal tax rate went up, the mechanic will pay a larger proportion of his earned income to taxes today than in the past. This is how federal income tax rates can remain the same, but workers end up paying more tax over time.

2. Eroding the Value of Debt

Inflation reduces the value of money. Let’s say we owe $100 to a friend and inflation is at 2%. We can pay back the $100 after a year. But by then its value would only be $98. Just about every major country in the world owes debt. The U.S. owes about $20 trillion. At 2% inflation, the value of this huge liability would fall by $400 billion a year. That’s a lot of debt to be forgiven. 🙂 The typical investor who buys fixed income funds would likely have government bonds in their portfolios. Unfortunately as a result of inflation, the bond holders (savers) get the short end of the stick while the government (borrower) becomes better off.

“As inflation shrinks the value of currency, it increases the relative value of equity investment. Thus, inflation is a process by which purchasing power is shifted from the middle and lower classes, who have their savings in fixed dollar investments, to the upper classes, who have the bulk of their wealth in equities.” ~Irwin Schiff

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Jan 142015
 

The basic concept of debt is simple. It’s when someone borrows money from another person. But once we start looking at different forms of debt such as sovereign debt, treasury bonds, mortgage-backed securities, demand loans, etc, it can start to sound like a different language to many of us. 😕

Even the money in your wallet right now is just another form of debt. It may not be your debt but if you trace back that money to its initial point of creation you’d discover who’s debt it belongs to. 😉

Year of the Debt

It has come to my attention that there is a lot of misinformation and confusion about the topic of debt on the internet. That’s why I’m making the proclamation that 2015 will be the year of the debt. I dedicate this year to write more about debt and its impact on our lives. I have even created a new section on the blog that’s all about debt.

15-01-year-of-the-debt

Most consumers are told that being in debt will hold them back from spending, investing, and living the life they want. But this is not entirely true.

Canadians now have more debt than ever before yet our average household net worth continues to reach record highs. So debt and wealth doesn’t have to be contradictory. In fact, often times debt can increase our financial well-being.Alberta has the highest household debt of any province, but they also have the highest household incomes. 🙂

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