Investment strategy in times of inflation: Understanding the deflated value and restrictive fiscal policies

The economic landscape of 2022 has been marked by a phenomenon that has completely transformed the behavior of financial markets and investment decisions: unprecedented inflation in decades. With record-breaking increases in consumer price indices and high interest rates implemented by central banks, investors face a clear challenge: how to maintain the purchasing power of their capital in an adverse economic environment.

For any investor, understanding key concepts such as the deflated value is essential in this new economic reality. This article delves into how these economic adjustments work and how they can directly impact your investment strategy.

▶ What is the deflated value really, and why does it matter in investing?

In economics, comparing figures over time is more complex than it seems at first glance. Phenomena like inflation or deflation distort nominal figures, hiding the actual economic performance.

How does the deflator work?

The deflator is a tool that expresses the change in prices during a specific period, allowing the isolation of real volume variations from simple price fluctuations. A deflated value is one that has been adjusted using this deflator, removing the noise of inflation or deflation.

To understand better: if you compare income from five years ago with current income, you can’t do it directly because prices have changed. The deflator adjusts both periods to a common base, enabling a fair comparison. For example, if a company reports revenue of 10 million in the base year and 12 million the following year, it might seem like a 20% growth. However, if prices increased by 10% during that period, the actual real value of the deflated figure only represents a 10% growth.

Applications of the deflated value in economics

This concept is constantly used to analyze Gross Domestic Product (GDP), assessing whether an economy is truly growing or if there is only inflation. It is also critical in investment analysis, where distinguishing between real gains and nominal gains can completely change your strategy.

▶ Deflating taxes: A fiscal measure under debate

Beyond pure economic analysis, there is a practical application of the deflator concept in fiscal policy: the deflation of Personal Income Tax (Impuesto sobre la Renta de las Personas Físicas).

What does deflating the Personal Income Tax mean?

This measure adjusts the progressive tax brackets to compensate for inflation, ensuring that taxpayers do not lose purchasing power simply due to nominal wage increases. If your remuneration rises by 5% but inflation is 6%, you have technically lost purchasing power. Without this deflation, you would also lose more due to a higher tax burden.

In countries like the United States, France, and Nordic nations, this adjustment is made annually. Germany implements it every two years. In Spain, at the national level, it has not been applied since 2008, although some autonomous communities have recently considered adopting it.

Impact on purchasing power

Proponents of this measure argue that it guarantees families and workers maintain their buying capacity in inflationary scenarios. Critics, however, point out that it creates inequality, mainly benefiting higher-income earners due to the system’s progressivity, and that it could increase demand, further pressuring prices.

▶ How to navigate investing in contexts of inflation and high interest rates

Inflation and restrictive fiscal policies affect different assets in various ways. A clear understanding of the deflated value will help you make better decisions.

Commodities: The traditional refuge

Gold has historically been considered a safe-haven asset. When inflation is high and money loses purchasing power, gold tends to preserve or increase its value, as it is not linked to any specific economy. In the long term, gold has steadily increased in value, although it shows significant volatility in short- and medium-term periods.

Stocks: Strategic selectivity

High inflation and elevated interest rates generally negatively impact the stock market, making corporate financing more expensive and reducing profit margins. However, not all sectors suffer equally. Energy companies demonstrated robust margins in 2022, while the technology sector faced significant pressures.

For long-term investors with available liquidity, recessions can present opportunities: stock prices fall, but historically markets recover and grow over the long term.

Forex: High volatility and risk

The currency market reacts sensitively to changes in inflation and interest rates. Elevated inflation can depreciate a country’s currency, creating opportunities for foreign currencies. However, forex is highly volatile, especially for inexperienced investors, and is subject to leverage that amplifies gains and losses.

Diversification and fiscal adjustment

Diversification remains critical: combining stocks, real estate, government-backed bonds, and commodities reduces risk amid changing market conditions. Additionally, it is essential to consider how taxes affect net returns: the deflated value of your investments after taxes is what truly matters for your wealth.

▶ Final reflection: The role of the deflated value in your decisions

Understanding the concept of deflated value is more than an academic exercise; it is fundamental to assessing the real performance of your investments. In an environment of persistent inflation and restrictive fiscal policies, distinguishing between nominal gains and real gains can mean the difference between believing you are prospering financially or discovering that your purchasing power has actually decreased.

If fiscal deflation measures were also implemented, disposable income for investment could increase, potentially boosting demand for various assets. This underscores the importance of being informed: knowing the impact of inflation, fiscal adjustments, and how the deflated value of your investments is calculated is the foundation of any solid financial strategy in times of economic uncertainty.