Recently, I was reviewing how different countries handle their fiscal policies during times of inflation, and I came across something interesting that many overlook: understanding what a deflator is is essential to grasp why some governments make decisions that seem contradictory.

When we talk about the deflator in economics, we are actually referring to an adjustment that allows us to compare real numbers over time without being misled by inflation. Imagine a company says its sales grew 20% from one year to the next. Sounds good, right? But if prices increased by 10%, the real growth was much lower. That’s what a deflator does: it removes the noise from price changes and shows you what really happened.

In Spain, this became very relevant when inflation skyrocketed a few years ago. Politicians started debating about deflating the personal income tax, which basically means adjusting the tax brackets so that people don’t end up paying more taxes simply because their nominal wages increased with inflation. Without this adjustment, someone might receive a salary increase that barely maintains their purchasing power but would end up in a higher tax bracket paying more taxes. In other words, they lose money in real terms.

What’s interesting is that other countries already do this routinely. In the United States, France, and Nordic countries, they deflate annually. Germany every two years. Spain, on the other hand, hadn’t done it at the national level for years, although some autonomous communities started implementing it on their own.

Now, why should this matter to you as an investor? Because it has direct implications on your purchasing power and where you can invest your money. If the government deflates taxes, people have more disposable income. That can increase demand in certain markets. And demand moves prices.

During periods of high inflation and elevated interest rates, investment strategies change quite a bit. Gold historically acts as a refuge when money loses value. Stocks suffer because borrowing becomes more expensive for companies, but not all are affected equally: energy stocks gained a lot in 2022 while technology stocks plummeted. The currency market offers opportunities if you understand that currencies depreciate with high inflation, but it’s extremely volatile and requires experience.

What many don’t consider is that although deflating the personal income tax sounds good in theory, the actual benefit for the average person is modest. We’re talking about savings of a few hundred euros annually. It’s not enough to massively change investment behaviors, although it can help on an individual level.

The key is to understand that behind any fiscal measure there is an economic mechanism. Understanding what a deflator is helps you read between the lines of public policies and anticipate market movements. When you see a government start deflating taxes, you know there’s more liquidity entering the system. That can mean opportunities in assets that respond well to increased demand, but it also requires proper diversification because volatility remains high in these scenarios.