A few years ago, when central banks began aggressively raising interest rates to fight inflation, many European governments faced an interesting dilemma: how to protect citizens’ purchasing power without completely stalling the economy.

This is where a concept that sounds technical but is fairly logical comes into play: deflating. In essence, deflating means adjusting economic figures to remove inflation noise and see what’s really happening. When prices rise by 10 percent but your salary rises by 5 percent, it looks like you earned more money. But when you deflate, you see that you actually lost purchasing power. It’s like removing the filter to see reality.

In economics, analysts use deflators all the time to compare the real performance of companies, regions, or countries over time. For example, if a country’s GDP grows from 10 million to 12 million in a year, it might seem like growth of 20 percent. But if prices increased by 10 percent over that period, the economy actually grew by only 10 percent. GDP adjusted for inflation is called real GDP, while the unadjusted figure is nominal GDP.

The most interesting application of this concept in recent years has been deflating the IRPF, Spain’s income tax. The idea is simple: if your salary increases because inflation pushes wages upward, you shouldn’t end up paying more taxes just for keeping your purchasing power. Many countries already do this automatically every year. In the United States, France, and the Nordic countries, it is standard practice. Germany does it every two years. But at the national level, Spain had not done it since 2008.

The reason this matters is that the CPI, the consumer price index, reflects exactly what people feel in their pockets. When the CPI rises, everyone notices that everything costs more. Without deflating the IRPF, taxpayers automatically move into higher tax brackets just by receiving nominal salary increases, losing even more purchasing power. It’s a perverse side effect of inflation.

Proponents of deflating the IRPF argue that it’s a matter of fairness: it ensures that inflation doesn’t penalize you twice. Critics counter that it benefits higher earners more, because the IRPF is progressive, and that cutting taxes could make it harder to fund public services. They also say that regaining purchasing power could increase demand and worsen inflation.

For investors, all of this has clear implications. In scenarios of high inflation and elevated interest rates, strategies change. Gold has historically held its value when the currency depreciates. Stocks suffer because financing costs rise and purchasing power declines, although some sectors—like energy—may benefit. The foreign exchange market becomes volatile because exchange rates move with inflation. And Treasury bonds, even though they are backed by governments, provide yields that need to be adjusted for inflation to be attractive.

Diversification is key when inflation strikes. You can’t bet everything on a single asset type because inflation affects each one differently. Some assets, such as real estate and commodities, tend to retain value during high inflation. Others, like certain technology sectors, can take a significant hit.

What many people don’t understand is that deflating the IRPF, even though it sounds important, probably only saves an average person a few hundred euros a year. It’s not an economic transformation. But in contexts of persistent inflation, every small adjustment counts toward keeping purchasing power intact. That’s why governments around the world do it regularly, adjusting tax brackets to the CPI so that inflation doesn’t turn into a silent tax on citizens.