Milton Friedman is often quoted as having said something to the effect that inflation is taxation without legislation on multiple occasions during his career (cf. for example Friedman and Friedman 1980, Ch. 9). In other words, he pointed out that inflation is a tax without democratic legitimacy. Citizens do not vote on it. Other economists before him, like Ludwig von Mises, made the same point and referred to inflation as an undemocratic form of government finance (Mises 1953, p. 223). But one can go even further than that. Inflation does not only lack democratic legitimacy. Upon closer inspection, it is one of the most unjust forms of taxation. It violates basic principles of justice and has a whole range of undesirable and harmful side effects.
Even moderate inflation is too inflationary
The official monetary policy goal of central banks around the world is a 2% annual price inflation rate over the medium term as measured by the Harmonized Index of Consumer Prices (HICP). We often tell ourselves that 2% is not a lot. It is a moderate rate that will positively stimulate the economy and lead to higher economic growth and wellbeing. But can 2% really be considered moderate? If one looks at the extent to which the money stock had to be expanded to achieve the target rate, it becomes obvious how excessively inflationary even a 2% inflation target can be.
Figure: Excess money growth in the euro zone, 1998-2026
Data source: Eurostat, ECB Data Warehouse
On average the official policy goal was almost met perfectly. The average annual increase in the HICP for the euro zone since 1998 has only been slightly above target, at 2.1%. This is primarily because of the recent hike in official inflation during the pandemic and after the outbreak of the war in Ukraine. Otherwise HICP inflation was mostly below target. In contrast, the average annual growth rate of the money stock M1 has been 7.1%. M1 increased from €1.7 trillion in December 1998 to €11.2 trillion in February 2026, that is, the money stock was multiplied by a factor of 6.5. To put this in perspective: the real economy only grew by 43% over the entire period, or by a meager 1.3% on average per year. There was thus excess money growth above real economic growth of 5.8% per year (7.1%-1.3%). We can say that the money stock had to grow this much faster than the real economy to get close – on average – to the targeted inflation rate.
However, this excess money growth is not simply a necessary tool to push up consumer price inflation to the declared policy target. It drives high and overproportionate inflation and speculative bubbles outside of consumer goods markets. They remain undetected by the official price index. It would thus be fallacious to interpret the HICP as the be-all and end-all of inflation.
Instead, it is important to understand the central role of the money stock. In the long run, sustained increases in the general price level are not possible without monetary expansion. This basic insight of monetary theory is implicitly acknowledged by the ECB itself. In August 2022, when official HICP inflation in the euro zone reached 9 %, the money stock M1 peaked at €11.8 trillion. The ECB responded by raising interest rates and allowing M1 to contract. Excess money growth was halted and temporarily reversed. Over the following months, official inflation gradually declined. The episode illustrates that central banks themselves recognize the inflationary consequences of excessive money creation. Under normal economic conditions, however, the effects of monetary expansion tend to appear primarily in asset markets rather than in consumer goods markets.
Inflationary pressures are primarily released on asset markets
Over the past decades price inflation has generally been much higher on asset markets than on consumer goods markets (Israel 2023). This is no surprise. Even if the general level of consumer price inflation is only at about 2% per year, households face strong incentives to change their saving behavior. This change triggers a structural shift in relative prices.
With persistent inflation – even if only at moderate rates – all cash holdings lose value over time. It is precisely in this sense that we can think of inflation as being a tax: The holders of money are made poorer, not because money is taken away from them directly, as in the case of regular taxation, but because their money loses purchasing power over time. This implies that certain forms of saving become less attractive while others become more attractive as they provide protection against inflation. Particularly holding cash, the easiest form of saving, as such, becomes economically self-defeating. But more generally all nominal assets with a fixed payout, such as bonds, become less attractive under inflation. Since interest rates must be decreased systematically to ensure monetary expansion, the payout on government and corporate bonds is reduced.
Inflation therefore changes saving behavior structurally: Demand shifts away from nominal assets and towards real assets, ideally with a highly limited, or inelastic supply. Supply can be inelastic for natural reasons as in the case of precious metals. They are hard to find in nature and costly to extract. But supply can also be inelastic for regulatory and bureaucratic reasons as in the case of real estate. Here it is not so much the natural cost of production that causes supply shortages, but rather artificial costs imposed by government regulation, such as zoning laws and environmental regulations. As long as the supply of a given asset is relatively inelastic, its price will tend to go up much faster when demand for them increases. Under inflation these assets provide a hedge against the devaluation of savings for those who own them. Their wealth position measured by its monetary value is inflated. The holders of such assets become richer at the expense of the non-holders for whom it becomes harder to acquire them (Israel 2023).
Inflation and investment behavior
The overproportionate inflation of certain asset prices triggers a shift in investment behavior: away from productive investments and towards speculative investments. While all investments are speculative to some extent, the qualifier speculative here refers to the buying and selling of existing assets without engaging in the production of new ones. Speculative investments can yield a profit simply through the price increase of an asset bought. In contrast, productive investments entail the purchase and combination of factors of production to produce new goods and services.
Under persistent overproportionate asset price inflation, it becomes relatively less attractive to invest productively and relatively more attractive to invest speculatively. One can simply buy an existing asset, such as an apartment in downtown Paris, hold on to it for a while and sell it at a much higher price, or use it as collateral in credit transactions to buy another apartment or leverage other investments. It is not necessary to produce anything to make a profit. Moreover, productive investments become even riskier in an inflationary environment. Hence, there is a crowding out effect: speculative investments replace productive investments.
This tendency has a detrimental effect on wage developments. Productive investments are needed to extend and preserve the existing capital stock in the economy. If the capital stock – that is, the machines and tools at the disposal of workers – is not improved through productive investments, then labor productivity cannot increase. By implication, wages cannot increase. The long-term evolution of real wages crucially depends on productive investments into the capital stock. The more these investments are crowded out, the lower will be the growth rate of real wages. In some instances, real wages have even decreased over the past decades (Israel and Schnabl 2024).
In this sense, we can argue that inflation imposes a particular burden on the working class through overproportionate asset price inflation and the resulting shift in investment behavior. It is as if an additional tax on labor income is imposed.
A tax on the poor, a subsidy for the rich
The inflation process entails a relative impoverishment of people who do not own appreciable assets and primarily depend on fixed wages, salaries, or savings held in cash. By contrast, those who own real estate, equities, or other appreciating assets are often able not only to protect themselves against inflation, but even to benefit from it through rising asset prices and capital gains. Inflation therefore tends to redistribute wealth from those who live primarily from labor income to those who derive substantial income from capital ownership. It acts, in effect, like a hidden transfer from the economically vulnerable to the economically secure.
This is what makes inflation not merely economically disruptive, but morally objectionable. A just system of taxation is generally understood to be transparent, publicly accountable, and to distribute burdens according to citizens’ ability to bear them. Inflation does the opposite. It imposes its heaviest costs on those least able to shield themselves from the erosion of purchasing power, while rewarding those with privileged access to appreciating assets, credit, and financial instruments. In this respect, inflation functions as a deeply regressive form of taxation.
For that reason, inflation is not only a tax without legislation as Friedman claimed; it is a tax that violates basic principles of justice. Rather than protecting the weakest members of society, it concentrates economic burdens upon them while benefiting the wealthy. It is difficult to imagine a more inequitable form of public finance.
References
Milton Friedman and Rose Friedman. 1980. Free to Choose: A Personal Statement. New York: Harcourt Brace Jovanovich
Karl-F. Israel. 2023. Wealth inequality: Causes and political responses. Geopolitical Intelligence Services, Report – November 28, 2023.
Karl-F. Israel and Gunther Schnabl. 2024. Alternative measures of price inflation and the perception of real income in Germany. World Economy, 47(2): 618-636.
Ludwig von Mises. 1953. The Theory of Money and Credit. New Haven: Yale University Press.
